Economic Update

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

Markets hit record highs

– US strong economic data
– China data impress
– Australian jobs hold up

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

In March, Wall Street’s S&P 500 reached all-time highs and our ASX 200 reached an 11-year high. To keep these results in perspective, both indexes are only just ahead of the 2018 September highs. 

The US reported some positive economic data in March. In particular, economic growth came in at 3.2% when trend growth is only about 2%. The market was only expecting 2.3%. Given the longest government shutdown occurred during this quarter one (Q1) – and the weather was quite bad – this result is one in the face for the recession merchants! 

In mid last year a significant number of commentators were calling for a recession starting with negative growth in Q1. In spite of the ‘unexpected’ economic strength, the Fed’s preferred inflation measure – the so-called core PCE – came in at 1.6% which is comfortably below the Fed’s target of 2%.

The US jobs data were also stronger than expected with 196,000 new jobs created in March and the unemployment rate is at 3.8%. Wage growth was a creditable 3.2% which is well above price inflation. If that wasn’t enough, US retail sales came in at a big 1.6%.

China too beat market forecasts for economic growth. GDP came in at 6.4% and retail sales, industrial output and fixed asset investment also beat expectations. Exports came in at +14.2% growth over the year.

With the US and China firing on all cylinders, global growth is not under threat – even if Europe isn’t doing well.

At home, the Reserve Bank of Australia (RBA) signalled that it will cut rates if the unemployment rate starts to trend upwards. The latest rate was 5.0% and it has been steady for some months.

A fair haul of new jobs were created in March; 25,700 in total and full-time jobs were at +48,300 swamping the part-time loss of  22,600.

So why are we all now worried about the Australian economy? The official data do not distinguish between food-delivery cyclists (and the like) seemingly growing exponentially and traditional jobs – and this switch also has an impact for average wage growth.

Moreover, our strong immigration numbers inflate job gains and economic growth. When per capita data are analysed our situation is more problematic.
The recent Federal Budget – if it all gets passed in parliament – is mildly stimulatory – and two RBA cuts if implemented, will provide a back-up monetary policy easing. Both parties are offering reasonably stimulatory policies going into the May 18th election.

In short, at last our economy may be getting the policy support it needs. That support can help our stock market especially as resources demand is supported by a strong China. There is also every chance of a compromise trade deal between China and the US being nutted out in May and presented in early June.

But the recent CPI data at home caused a stark reminder of what might happen if economic policies do not get through parliament and the RBA sits on its hands. Our latest inflation read was actually zero! When highly variable components are extracted to get the RBA-preferred number, inflation jumps only to 0.3% for the quarter, or 1.6% for the year. That growth is well below the 2% to 3% target of the RBA.

But, on a lighter note, maybe we should follow the Ukraine in voting in a TV comedian as the new president with a landslide victory. We doubt if anyone thinks he can do well but it is confirmation that people right across the globe are fed up with the current style of politics on all sides in all countries.

Asset Classes
Australian Equities

The ASX 200 posted a fourth straight month (+2.3%) of positive gains in April making a gain of +12.0% over 2019 to date. There was great disparity among the gains across sectors. Consumer Staples (+7.3%) and IT (+7.3%) were the very big winners with Materials ( 2.1%), Property ( 2.6%) and Utilities ( 0.5%) going backwards.

By our own measurements, we see the end-of-year forecast for this market to be stronger than we did at the beginning of the year. We have the market only mildly overpriced and so that does not seem to be a headwind for markets. 

While there maybe heightened market volatility around the May 18th election, if so we expect this to be a short term event.

Foreign Equities

Many have suggested there would be an ‘earnings recession’ in the US – a recently thought-up concept to suggest two negative quarters of earnings growth. The current Q1 earnings are well below the bumper Q4 results but Q1 earnings growth is strongly positive which no doubt played a large part in propelling the market to new highs.

In spite of global doubts by some and the strong run-up in markets since the start of the year, there have been some amazing gains on international markets. The S&P 500 posted +3.9% for April but Japan’s Nikkei came in at 5.0% and the German Dax at +7.1%! 

Bonds and Interest Rates

The CME Fedwatch tool for pricing possible rate changes by the Fed this year keeps changing on the slightest news. There is little or no credence being given to a rate hike this year and the probability of no change is varying between 30% and 40%. The real movements are in the possible number of rate cuts this year. The latest strong GDP data brought one cut to be a little more dominant than in recent times. Indeed, one cut currently has a much higher probability than no changes this year.

At home there is a 50% chance being priced in for a cut in May by the RBA. Given the proximity of the Federal election, May seems unlikely to us as that might be used to signal an unwelcome comment on past economic management. But two cuts this year seems almost a certainty. 

Other Assets

Oil prices were the biggest movers of the major commodities. They were up over 5% in April. Part of this move is due to Trump’s sanctions on Iran but Trump has also encouraged the Saudis to play their part in stabilising prices.

Regional Review
Australia

The general election is rapidly approaching and both sides are offering the usual sweeteners to voters. Either way, there is likely to be some stimulus coming our way soon. However, as with previous elections, there is unlikely to be a majority for one party in both houses so deal making will have to happen to get the bills through.

With inflation remaining well below the target range there is every chance of rate cuts that might help stabilise the housing markets.

Jobs data remains quite strong but we believe the basic statistics mask some of the changes that are going on within this – and other – economies. Technology improvements and home delivery services are changing the balances. It is difficult to assess what the real situation is. The weak wages growth supports the notion that all is not well in the labour market. Nevertheless, the latest monthly data shows that 48,300 new full-time jobs were created in March.

China

The latest economic growth data did not disappoint the People’s Republic forecasts made in the previous month. A 6.4% outcome for Q1 against an expectation of 6.3% supports the notion that China’s stimulus policies are working.

All of the other major partial economic indicators beat expectations – except for the latest manufacturing index that came in at 50.1 when 50.5 had been expected. Nevertheless, 50.1 is above the 50 level that divides expected growth from expected contraction.

US

A bumper economic growth figure of 3.2% boosted Trump’s economic management message. The negative commentators whose expectations have not come to fruition are now looking for reasons why the next number will be lower. The Boeing crisis is now being estimated to take 0.1% to 0.4% off Q2 growth.
With trend economic growth at about 2% there is a lot of wiggle room before published data suggest a real slowdown.

It is hard to watch any of the overseas business TV channels without being inundated with claims and policies from a long list of would-be Democratic nominees for the 2020 election.  

The problem when so many candidates are in the running is that policies have to become wilder and wilder to get the attention of the media. Hopefully, candidates will start to drop off soon due to lack of funding so that a sensible debate about how the US should be run can emerge.

Europe

The Brexit deadline seems to have been moved back to Halloween (with a hurdle or two before) so that Brexit is less of a distraction for markets.
In further moves to political instability around the globe, Spain just voted back in a socialist government but ‘with a far-right breakthrough’.

Economic conditions in Germany are far from great and the car industry is suffering from US trade policy.

Rest of the World

It is difficult to ‘top’ the report that the Ukraine voted in a comedian to be its president (he actually plays the part of a comedian who becomes president in his new series). But, after the recent failure of the Trump-Kim nuclear talks, it is interesting to see Putin and Kim are getting their knees together under the table.

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

Markets remaining bullish!
Global recession fears not abating
US Fed on hold for 2019

RBA acknowledges rates may go down in Australia

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

After two very strong months on global stock markets, which completed the recovery from the correction in the December quarter of 2018, markets were flat to positive in March. That behaviour was inevitable but the narrative surrounding the end of the recovery was somewhat of an over-reaction, in our opinion.

The US Federal Reserve (Fed) last raised cash rates in December 2018 and then forecast two more hikes for 2019. At the March 2019 meeting, the Fed signalled no more hikes in 2019 and the markets started pricing in the possibility of cuts. There was heightened talk about a global slow-down causing this change in stance.

Possibly precipitated by the Fed policy, ‘the US yield curve became inverted’ on March 23rd. Usually, the short-term interest rate – such as the 90-day-bill rate – is below the rate at the long end – say the 10- year bond rate. When the short rate is above the long rate, the so-called yield curve is said to be inverted.

Inverted yield curves are rare and are often associated with an impending recession. The last time the US yield curve was inverted was in mid- 2006 before the GFC but we think the 2019 version is different.

An inverted yield curve is usually caused by the central bank jacking up its short-term rate while the interest rates on longer term instruments such as Government bonds moves less because they are tied to inflation expectations. That’s what happened in 2006 but not in 2019.

The current US cash rate is about half of what it was in 2006. This time, it was the interest rate on longer term instruments which fell on the news that the Fed had stopped increasing the cash rate as inflation was not, in their view, a current issue!

No one is suggesting that there is a causal link between yield curve inversion and recession. Rather, both are usually caused by common factors. At the end of March, the final estimate for US economic growth in 2018 came in at 2.9% which is comfortably above even moderate levels.

At home, our central bank, the RBA, kept the official cash rate on hold. But the economic growth figure for the December quarter of 2018 (Q4) came in at only +0.2% only days after the RBA interest rate announcement. The RBA’s expectation was for +0.6% for Q4 and 3.0% for 2019. The market too predicted +0.6% for Q4 a few days before the data release but cut that forecast to +0.3% the day before. RBA Governor, Philip Lowe, stated that “it’s hard to see a case for a rate hike this year”.

The situation was not helped when the US jobs data was particularly soft. Only 20,000 new jobs were reported in the month of February but that month’s employment was affected by the partial government shutdown caused by Congress’ failure to agree on spending. The jobs’ report was delayed in its release because the data collection agency was also affected by the shutdown. This data announcement might well be revised upwards. The new reported unemployment rate was down to 3.8% from 4.0% and wages growth came in at 4.3% which is the highest since the GFC. Consequently, we are not in the naysayer’s camp as these economic data announcements are continuing to confirm robust growth in the US.

Naturally China played a big role in shaping the broader views of economic prospects. The official China growth forecast for 2019 is in the range of 6.0% p.a. to 6.5% p.a., a fraction down on the 2018 outcome. But in an attempt to stimulate the economy Chinese authorities have cut the (GST-equivalent) value added tax (VAT) rate to 13% from 16%.

The China-US trade talks resumed at the end of March. There appears to be widespread hope of some sort of resolution to the impasse – but just not yet.

The Brexit negotiations are now outdoing even the best of the Monty Python sketches. The UK PM took the same bill back to the UK parliament for a third vote after it had failed twice. She had offered to stand aside if that last vote had been successful and stay if it failed!

We still think the fundamentals of the ASX 200 and Wall Street are strong but all eyes will be on the latter’s Q1 reporting season that starts in a couple of weeks.

Asset Classes

Australian Equities

The ASX 200 climbed +0.2% in March after two great months (+3.9% in Jan. and +5.2% in Feb.). While the more defensive listed property sector lead the ASX 200 in March rising +6%, the index was negatively impacted by Energy (-4.7%) and Financials (-2.8%).

We assess the local market as being about fairly-priced at the moment. With the next reporting season four months away, the market will be more reliant on the macro and political picture than company news at least in the interim.

The Australian Federal Budget, due on April 2nd, could well provide some fiscal stimulus that will help both the economy and the market. With the Federal election looming (forecasts are for May 11 or May 18), the government may well wish to announce some electoral sweeteners to kick off the full election campaign.

Foreign Equities

The S&P 500 posted a gain of +1.8% in March making it three strong months in a row – and the best opening quarter since 1998! We have that market fairly to fully priced but their next (quarterly) reporting season is only two weeks away and will provide more insight on longer term valuation.

With some investors and commentators focusing on a possible recession in the US, the company outlook statements will be key to the medium-term future of US shares.

In spite of the failing Brexit negotiations, UK equities posted a strong March (+2.9%) but the German DAX struggled with a +0.1% gain on a slowing economy.

Bonds and Interest Rates

The Chicago Mercantile Exchange (CME) Fedwatch tool for pricing possible rate changes in the US is now set at about 34% probability for no change in the US cash rate in 2019 and 41% chance for one cut in the cash rate, 20% for two cuts and 5% for three cuts! There is even a slight chance (0.6%) given to their being four cuts in the rest of this year! This distribution represents a significant change to the down side in expectations for US cash rates from expectations in February.

In Australia, the RBA official cash interest rate was ‘on hold’ at 1.5% in March but we think the RBA could cut the rate a couple of times in 2019. With the Budget in April and the election in May, it may have to wait until June for its first opportunity to make the first cut. If this were to occur, we expect the second in rapid succession.

In Europe the European Central Bank (ECB) has further delayed its plan for a rate rise. The softness in the key German economy being a contributing factor.

Other Assets

The price changes for the major commodities were quite mixed: oil was up 3% while copper was down by a similar amount. Iron ore was flat and gold was down nearly 2%.

Regional Review

Australia

The jobs report in March revealed a modest jobs’ gain of +4,600 but there were +20,600 new jobs in the ‘official trend data’. The unemployment rate did fall from 5.0% to 4.9% but the trend rate was flat at 5.0%.

The Q4 GDP reading came in at +0.2% making economic growth for a second half of the year at a modest +1.0%. However, a strong start to 2018 produced an acceptable +2.3% for the year. In 2019 it could be a different story if the moderating trend continues.

The Westpac’s consumer sentiment measure dropped sharply below the 100 level to 98.8 from 103.8.

If the RBA does cut the official cash rate twice this year and the April Budget produces a reasonable fiscal boost, the risk of a recession in Australia this year at least is substantially mitigated. However, if both monetary and fiscal policy fail to address the current moderating economic situation then our economic prospects will be more subdued.

China

The People’s Congress published an economic growth forecast range of 6% to 6.5% for 2019. The Congress usually gets what it wants!

It is planning to promote growth through a cut in indirect taxes and an increase to infrastructure spending. China’s trade data were again out of line with expectations but this variance is quite likely due to both new and possible tariffs and the ongoing trade negotiations with the US.

China’s increase in soybeans and auto imports from the US helped produce the biggest cut in the US trade deficit for 10 months hence it appears some changes in trading patterns are underway. The trade talks with the US resumed at the end of March.

The manufacturing PMI (Purchasing Manager’s Index – a measure of confidence and demand of companies) jumped 1.3 pts to 50.5 after three months operating below the 50 mark. A reading below 50 indicates a contraction a reading above 50 indicates expansion.

US

Delayed US growth data produced a first revision for the previous Q4 (December 2018) release to 2.6% at the start of March but this was brought back to 2.2% for the final Q4 read at the end of March. The figure for 2018 as a whole was 2.9%, just below President Trump’s forecast of 3%. The US Federal Reserve chair, Jerome Powell, now predicts 2.1% for 2019 from his December forecast for 2019 of 2.3%.

US core inflation was +0.1% for the month and 2.1% for the year – just on the Fed’s target. The broader inflation reading that does not exclude highly variable components came in at +0.2% for the month and +1.5% for the year. US inflation is currently not an issue and the Fed has stated that it would even be happy if inflation did come in a little higher before it felt the need to hike rates.

The Mueller report concluded that US President Trump did nothing illegal in the widely-discussed Russian attempt to influence the US 2016 election outcome. Trump cannot be impeached on that but the Democrats are still looking for angles to discredit the president.

US retail sales came in at 2.3% for the year. All in all – when data glitches are accounted for – the US economy is not heading for recession in 2019 – in our opinion!

Europe

Unlike in the US, European growth is slowing and it needs some stimulus – as does Australia – to avoid a bleaker future. Some of the growth problems emanate from Trump’s tariffs on German cars. It is not just China that is in the cross-hairs of US trade policy.

The Brexit saga should have ended by now. It was all due to be resolved by last Friday, March 29th but a short extension to April 12th was granted. The UK Prime Minister, Theresa May, continues to try to get a resolution but it is appearing to be bordering on the impossible. A number of choices were put before parliament but all were rejected!

A major stumbling block is the treatment of the Eire – Northern Ireland border as the southern Irish Republic will stay in the EU. Moreover, UK Prime Minister May’s government relies on the support of the Northern Ireland conservatives in her coalition majority. After decades (and centuries) of disharmony that was resolved at the Good Friday (1998) Agreement no one wants to return to the bad old days of disunity in Ireland.

Rest of the World

Turkey continues to be embroiled in economic and political crises. In the last week of March, the swap rate for the lira (an interest rate for borrowing the currency overnight) touched 1,000%. At least our economic problems are manageable!

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

Australia economic data beat expectations
– Australian growth and labour force data strong
– US confidence at 18-year high
– Trump trade tariffs diluted

The Big Picture

For a change, major Australia economic data releases looked strong – at least on the face of it. Our economic growth measure came in at +3.4% for the year which is above trend by anyone’s opinion. The quarterly figure was +0.9% against an expected +0.7%.

The problem with this surge in growth is that it has been fuelled by a dangerous fall in the household savings ratio. In the last quarter, this ratio was only 1% compared with double figures after the onset of the GFC. It would be alarming indeed if the savings ratio stayed at such a low level and so future economic growth will no longer benefit from falling savings. The 3.4% figure looks like being the peak for quite some time.

Our labour force data was also strong. The unemployment rate stayed at 5.3% but 44,000 new jobs were created and 34,000 those were for full-time positions. These data are undeniably good.
Westpac’s consumer sentiment index did fall 3% points – possibly because yet another change in prime minister. The Reserve Bank (RBA) kept rates on hold but that did not stop three big banks raising home loan rates. Since banks get much of their funding from overseas, the RBA rate alone does not control bank lending rates. But a rate hike for home owners slows things down whether it comes directly from the RBA or from the knock-on effects of overseas rate increases.

Unlike in Australia, US consumer confidence just reached an 18-year high and quarter two’s economic growth figure was confirmed at 4.2%. The US economy is very strong with another 200,000 jobs being created over the month and the unemployment rate is at a very low 3.9%.

The strength of the US economy allowed the Federal Reserve (Fed) to hike its rate as expected by all. The new range is 2% to 2.25% and 2.5% is widely considered to be a neutral rate. The Fed removed the word ‘accommodative’ from its press release. The big questions are whether they will hike again in December and how many more hikes will come in 2019. 12 of the 16 Fed members think they will hike again in December and the consensus is for three more hikes in 2019. That would mean monetary tightening in the second half of 2019.

The market is less sure of future hikes. It thinks there will be only one or two next year. If the Fed goes ahead with its thinking, markets could slow down late in 2019.

Nobel Laureate, Robert Shiller, a particularly practically-orientated Yale professor was interviewed on Bloomberg TV. He stated quite firmly that no one can predict turning points in markets with any reasonable degree of accuracy. Although the S&P 500 hit all-time highs again in September he argued that the market could go higher by as much as 50% – based on a comparison with statistics during the dotcom boom at the turn of the millennium.

Trump broadened his imposition of new tariffs on China imports as expected. However, he set the rate at 10% rather than the expected 25%. However, if a deal isn’t reached beforehand, the tariff automatically jumps to 25% on January 1st. China of course retaliated but the escalation of the tariff war so far seems milder than many expected.

North Korea noticeably did not display missiles in its 70th anniversary parade in September. The next day, their leader wrote to Trump requesting further talks. The tensions at the beginning of the year have largely dissipated.

Asset Classes
Australian Equities

Our ASX 200 had a down month ( 1.8%) in September after five successive months of capital gains. The resources sectors each had a particularly strong month but Financials and Healthcare really brought the index down.

When dividends, but not franking credits, are included, the ASX 200 was down 1.2% on the month but up +5.9% on the year after the end of three quarters.

Foreign Equities

The US’ S&P 500 has now enjoyed six successive months of capital gains and its bull run – the longest in recorded history – looks set to continue.

In spite of all of the negative sentiment about tariff wars, the S&P 500 index is up +9.0% on the year to date which is well ahead of the world index at 4.1%.

London’s FTSE was up 1% on the month despite the gloom about getting a Brexit deal in time.

Bonds and Interest Rates

The US Fed put rates up by 0.25% points at the September meeting. The Fed funds rate range of 2% to 2.25% is now close to what is widely thought of as a neutral rate of 2.5%. At a lower rate, the Fed is said to be accommodative and above that it is tightening.

With the Fed “dot plots” presented at the press conference showing one more hike this year and three next, the Fed is clearly thinking the economy could grow too strongly on the fiscal stimulus created by the Trump administration.

Other Assets

Prices of oil, copper and iron ore grew strongly over September. The price of gold slipped a fraction.

Regional Analysis
Australia

The strong economic growth for quarter two released in September was better than expected. However, the household savings ratio is back close to zero – which is where it was at the start of the GFC. Households then over-corrected their savings strategies for the first few years but in the last couple of years, households have gone back to the bad old ways of not saving enough.

This savings behaviour, together with strong immigration, means that our annual growth of 3.4% is an overstatement of what could be reasonably considered to be sustainable in the medium term.

The jobs data were good with 44,000 new jobs being created in August. However, consumer sentiment fell by 3% points. The RBA was on hold.

China

China has had import tariffs applied to a wide range of goods imported by the US. So far, neither the US nor China economies seem to be adversely affected.

China’s official Purchasing Manager’s Index (PMI) for manufacturing did miss expectations at 50.8 but the services PM rose to 54.9 from 54.2 in the previous month. It is a natural consequence of a maturing economy that there is a gradual switch from manufacturing to services. Both the manufacturing and services reads were well above the 50 that divides improving growth rates from declining growth rates.

US

The US consumer confidence read came in at 138 which is well above a neutral read of 100. The latest number is the best in 18 years taking us back to the dotcom boom.

Trump is positioning his party for the November mid-term elections. By taking on China toe-to-toe, he is gaining support from both sides of politics. If a deal is struck with China, it will be a big boost to markets.

Europe

Italy is taking on the EU by increasing its fiscal deficit programme. It is far from yet being an important issue but, with two populist parties now in power, it might be a sign of worse to come.

Rest of the World

North Korea is rapidly becoming a problem solved in the nuclear debate. While few applauded the way in which Trump went about this situation, the results so far are extremely encouraging