Economic Update

Economic Update July 2017

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
Strong signs of continued world economic growth
– Europe has shaken off its recent rocky economic road to recovery
– Signs of life in Australian employment data
– Bank tax might limit growth in the ASX 200 during FY2018
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 

At the start of a new financial year, it is natural to reflect on our performance over the last one.
In just one year, Europe has gone from being ‘the problem child’ of world economies to a shining light, growing at above trend with past political squabbles having largely subsided.
The US has moved from a grid-locked Obama government to an economy of great hope. True, Trump is struggling to make his mark on a number of fronts but much of the economic data have been solid. If Trump can get his tax cuts, infrastructure spend and healthcare reform through, the USA economy will also run at well above trend.
China has again shown the bear market proponents to have been premature in calling the end to its strong growth path. China has announced a truly massive multi-country infrastructure project, ‘One belt, one road’ that will link the eastern part of Asia with the rest of the continent, Europe and Africa. With the new government taking over later in 2017, there is a reasonable expectation that they will be even better able to continue strong growth.
Not all is well. The UK was doing quite well until May called an election – which backfired on her. She has a two-year deal with a conservative Northern Ireland party (DUP) to form government and see ‘Brexit’ through. How she goes in negotiating Brexit is the key to the success of the UK economy.
Australia too is not yet out of the woods. Recent employment data have shown strong signs of life but not yet for long enough to call it a strong recovery. With our latest economic growth at a low +1.7% over the year, the government needs to get some runs on the board in terms of policy and it would help if the Reserve Bank came to the party with a rate cut.
Some worry about house prices – particularly in Sydney. Students of the property market would know that it is entirely normal for average house prices to be stagnant for up to a decade and then go through a period of very rapid growth as we have just seen. We had similar price growth in Sydney up until 2003 only to be followed by a shallow but elongated dip into 2013. If we now start another ‘property price plateau’, it is just business as usual. That is our position.
So the next financial year is looking to be a source of more growth in stock market indexes around the world – but that gains in Australia may again be a bit more muted than others.
The ‘bank’ tax is likely to weigh on the share prices of the whole financials’ sector. As that sector is about 40% of the ASX 200, the other sectors will have to do most of the work over FY2018. Nevertheless, the ASX 200 should continue to pay solid dividends with franking credits.
The main economic events to monitor over the coming financial year are the Brexit negotiations in Europe and how the US Federal Reserve (“the Fed”) handles its so-called ‘budget repair’. From around September, the Fed plans to stop buying all of the new bonds necessary to completely offset those existing Treasuries that mature.
Given that they plan to reduce the 4.5 trillion dollars of debt to about 2.5 trillion over several years, skill will be needed but we think the Fed has learnt so much from its ‘tapering’ program of a few years ago.

Asset Classes 

Australian Equities

The ASX 200 closed the financial year up +14.1%, including dividends, over 12 months. We are predicting a return to more average growth over FY18 with the ASX 200 finishing at about 6,150 next June. Of course, there will be bumps along the way especially round September-October as the Fed starts to move and Trump faces renewed uncertainty after the August recess for Congress ends.
Our market would have looked even stronger if the Telco sector hadn’t tanked -21.7% (including dividends) over the last 12 months. The Materials sector, including the likes of BHP and RIO, notched up a 12-month return of +25.8% including dividends.

Foreign Equities 

The so-called ‘FANGs’, being Facebook, Amazon, Netflix, and Google (Alphabet), suffered some significant stock price volatility in the US in late June. Since these companies comprise 55% of the NASDAQ index and 37% of the S&P 500, their fortunes a have much wider impact on Wall Street – just as our big four banks do in the ASX 200.
While some question whether this could be the start of a market correction, others just point to the strong earnings growth. Of course, the massive fine the EU placed on Google for favouring its own advertising clients was a real negative but it only knocked its stock price down by about -2% on the day.
That the Fed gave a ‘pass’ to all of the banks in the second round of stress testing gave all markets a big kick up. These US banks can now start returning money to shareholders in dividends and share buy backs.
Capital gains were strong around a number of major markets during FY17: S&P 500 (+16.2%), London FTSE (+12.4%), German DAX (+31.5%) and the Japan Nikkei (+28.6%).

Bonds and Interest Rates 

The RBA did not change rates in June and it has not signalled any inclination to do so – at least in the near future.
On the other hand, the US Fed hiked rates by 0.25% as was widely anticipated. The Fed further clarified its plan to ‘repair its balance sheet’ which markets took in their strides. It is expected that this program will be started in September but at such a gradual rate that markets should not be perturbed.
The Bank of England was also on hold and its governor stated that he did not expect to hike rates this year – but he would if business investment took off.

Other Assets

Both iron ore and oil prices continued their slides into June but, iron ore prices jumped by about +10% and finishing up +11.3% on the month.

Regional Analysis

Australia 

There is now a reasonable prospect that the Australian labour market data may have started to recover without the need for extra policy changes. With now three successive months of good employment data, and a blip down in the unemployment rate, a new trend may have emerged.
The Governor of the RBA, Philip Lowe, has talked up the employment data by saying it is accommodating those people who prefer not to work full time. We believe that the almost non-existent wage inflation does not support this view.
To be on the safe side, we think a rate cut would help support the economy while the government tries to get its new budget through parliament. We see no risk to house-price inflation from a cut as we believe recent Sydney price behaviour has been following the usual pattern of house prices across all states for many decades.
June closed with Dr John Edwards, a former board member of the RBA, calling that there would be eight rate increases in the next two years. This is known in the trade as an attention seeking forecast. He can dine off it no matter what happens for six months. If he gets close he looks like a hero. If he is way off the market as we and seemingly everyone else thinks his forecast will be forgotten and so will he. Nothing to lose on John’s part!

China

China’s Industrial Profits jumped +15.7% (annualised) at the end of June to spark the reversal in the price of iron ore. Other data were also very strong such as the Purchasing Managers Index (PMI) for manufacturing up to 51.7 from 51.2 when 51.0 was expected. The services PMI was again stronger at 54.9 from 54.5.
We have no reason to expect China will miss its growth targets. Indeed, a former member of the People’s Bank of China was recently reported by CNBC as having said that he believes the new government – due to be appointed in October – is likely to be more aggressive in attaining economic growth targets. This reasoning is apparently based on the recent work having been done to stamp out corruption in some sections of government. The new government starts with a clean slate.
U.S.A. The US labour market lost some strength over the past few months – but not enough to worry. The last jobs number came in at +138,000 new jobs when +185,000 were expected – and the previous month’s data was revised down from +211,000 to +174,000.
There has been some noticeable price growth in the housing sector but not nearly enough to cause concern. The hike of 0.25% in the Fed Funds rate in June was the second for the year. Since this was widely anticipated and welcomed. It should not have any negative consequences for the economy. The big question is whether the budget repair program from September will effectively raise rates and hamper economic growth.
Given Trump’s problems with his second attempt at reformulating the healthcare policy, it does not look good for a swift move to infrastructure and tax cuts. However, we expressed such a view of a delay at the beginning of 2017. Perhaps the market just got a bit ahead of itself! But the Fed’s stress testing positive results for the banks have big implications for economic and market growth.

Europe

President Macron had a major victory in the wider French elections. This bodes well for economic stability in the region. The Purchasing Managers’ Index (PMI) for manufacturing hit a six-year high in June.
The President of the ECB, Mario Draghi, has announced no more rate cuts to follow. However, he is thought to have a gentle touch for when he eventually starts a tightening policy.
The UK is showing early signs of softening growth. There have been some differences of opinion from the Bank of England Governor, Mark Carney, and his Chief Economist. Carney was adamant that there will be no rate hikes this year. Then he said he would if business investment warranted it.

Rest of the World 

North Korea continues to be a thorn in the side of the rest of the world with its missile testing program.
Qatar, too, has attracted negative attention. It is claimed that their actions have helped contribute to the strength of the terrorists in the Middle East. Sanctions are being discussed but Qatar happens to be the location of the largest US air base in the region!

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

Economic Update June 2017

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
Support mounting for RBA rate cuts
– Popular Federal Budget
– United States (US) Federal Reserve maps out recovery phase
– China downgraded by Moody’s
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
While most market commentators are predicting no rate changes for Australia in the rest of 2017, three major houses recently re-affirmed their call for cuts.
JP Morgan and Credit-Suisse are predicting two more cuts this year which would take the RBA rate to 1%. Macquarie re-affirmed its call for three more cuts to less than 1% in this ‘cycle’ – that is, in 2017 or early 2018.
We maintain our call for two more cuts. We first identified and reported a growing problem in our full-time employment creation in April 2016. While total employment has been growing steadily, part-time jobs have been replacing lost full-time jobs.
The May Federal Budget gave some long-term hope for our economy with the infrastructure spending announced over the next ten years. The proposed tax cuts for small businesses will also help. But the increased Medicare levy and the bank tax will work against growth.
Both Moody’s and S&P re-affirmed the country’s AAA rating after the Budget.
There is no doubt that the bank tax will be passed on. No company can absorb substantial taxes by cutting costs over an extended period. The only question is whether shareholders or bank customers will bear the brunt. First-year economics teachings lead us to believe the burden will be shared.
Since the big four banks plus Macquarie form the basis of many super funds – directly or indirectly – the Australian public will have less to spend even if the banks do not raise rates to cover the tax.
On top of the bank tax, Moody’s just downgraded 23 smaller banks. The impact of this change in the ratings will be to increase the cost of funding for smaller banks. Therefore, we expect pressure on the banks to lift rates – or not reduce them by as much as any cuts made by the RBA.
The US Federal Reserve mapped out a well-received plan to ‘shrink its balance sheet’. That is, the $4.5 trillion debt amassed in quantitative easing since the GFC is to be reduced in gentle stages starting this year.
The balance sheet is to be repaired by not buying sufficient new bonds to replace all of those naturally maturing – as the Fed has been doing for years. This ‘tapering’ will have the effect of raising long-term rates. Therefore, we continue to expect that there is probably only one more hike in the US likely this year. The market has placed around an 80% chance of a rate hike in June.
At the start of the year, the Fed predicted three hikes this year and then seemingly upped that to four as Trump talked up his expansionary plans. With only one hike so far this year, the Fed again has been overly optimistic about the strength of the US economy.
China reported some very strong trade data – both imports and exports – but Moody’s downgraded China in May!
On a very positive note, Nobel Laureate Robert Shiller has said that the US stock markets could go up by another 50% and most other markets could go with it. This statement is particularly strong as Shiller’s own ‘PE ratio’, measuring whether a market is expensive or not, has been used for a couple of years or so by others to say that the US market was overpriced and about to correct!
In conclusion, we see Australia and our major trading partners’ economies making gradual improvements and the stock markets unlikely to suffer more than the usual levels of volatility.
Asset Classes
Australian Equities After three months of solid growth, the ASX 200 fell in a hole during May ( 3.4%). While there are many factors at work, the fact that we lagged behind the world indexes strongly suggests that the proposed bank tax was the major culprit. The financial sector is about 40% of the ASX 200 index.
While the ASX 200 reached a recent high of 5,957 during May – up from the 5,924 at the start – the index fell away into the close of the month. Stocks in Energy (+2.0%), Industrials (+4.7%) and Telcos (+3.4%) were up strongly in May. It was the  9.2% fall in Financials stocks that did the damage.
Of course the new bank tax might impair future dividends from the big banks but the damage should not be big enough to affect the super strategies in which many have invested.
In the coming weeks there may be some clarity on how the tax will be implemented and how the banks will deal with it. At that point we believe that bank stocks could rally because – in times of great uncertainty such as now – markets often ‘over sell’ the problem stocks.
Foreign Equities The VIX ‘fear’ index (which is considered by many to be a proxy for investors taking out insurance on downside risk in stock markets) reached twenty-year lows during May – only picking up to average levels when the Trump-FBI story peaked.
Wall Street hit new all-time highs in May with the S&P 500 breaking through the 2,400 barrier. Most other major indexes also performed very well in May.
People are mixed on whether the index can rise further since many have risen strong so far in this year. For example, the S&P 500 is up +7.7%; the London FTSE is up +5.3%; the German DAX is up 9.9%; and the Japanese Nikkei is up 2.8% (all figures year-to-date). The ASX 200 is only up
1.0% in the same time period.
For the moment we stand with Shiller in that we think markets can go higher from here.
Bonds and Interest Rates
The RBA did not change rates in May and it looks very unlikely to do so in June. There has been some swing towards acknowledging our weak labour forecast data by analysts and the RBA which might encourage the RBA to cut later in the year.
The US Fed released a particularly informative minutes from its recent FOMC meeting. It outlined a clear plan to start reducing the debt amassed during the quantitative easing programmes.
Such a programme would put upward pressure on longer bonds meaning that the Fed would be ill-advised to amplify that effect with hikes in the Fed funds rate. As a result, we think our view that the Fed only has one more hike in line for the economy this year is worth holding on to.
Other Assets Iron ore prices fell further in May – by  15.5% but oil, copper and gold finished fairly flat. The OPEC meeting on May 25 helped restore some stability in oil prices.
Regional Analysis
Australia The last two months have witnessed strong growth in full-time employment after more than a year languishing in negative growth territory. The key question is whether these latest data mark the start of a recovery or a statistical artefact. Unemployment remains stubbornly high at 5.8% and wages growth came in at +1.9% for the year – which is the lowest on record. Weak wages do not usually accompany strong labour markets.
Since the proposed Federal Budget infrastructure programme and company tax cuts will take some time to work their way through the economy, the RBA would do well to cut rates once or twice this year to kick start growth in 2017. GDP growth data are due out early in June and most expect a low number – and possibly even negative growth.
In contrast to the hard data, the soft data on confidence and conditions are quite reasonable. Westpac’s consumer sentiment read stands at 98 which is just below the ‘100 level’ that separates pessimism from optimism. NAB’s business confidence came in at the highest level since before the GFC and their business conditions index is the highest since 2010.
All in all, the economic scene is mixed but not bad. A lot depends on which parts of the budget the government can get through parliament. And an accommodative RBA is important.
China
China recorded impressive import and export data in May that beat consensus forecasts. The Purchasing Managers Indexes (PMI) for both manufacturing and non-manufacturing were strong. Nevertheless, there remain some commentators that persist in talking about China slowdowns.
China is talking up a big infrastructure initiative known as ‘One Belt, One Road’ which aims to link both ends of Eurasia and well as Oceania by land and sea. This programme, together with its stated desire to relocate 200 million more citizens from the country to the cities, could ensure continued strong growth for many years to come. Nevertheless Moody’s downgraded China debt for the first time in 26 years! China was not happy about that!
China’s retail sales again grew in double digits and industrial growth was solid at 6.5%, but slightly down on the previous month’s 7.1%.
U.S.A.
The USA fell into a political hole when the debate about what Trump did and didn’t do with respect to the FBI chief and Russia got going. Cries of impeachment were heard from some corners but that is highly unlikely. Importantly, the airwaves cleared quickly as Trump set off on his first overseas trip as US President.
The response to Trump’s visits was mixed. He was well received in Saudi Arabia and Israel but he ruffled feathers in Europe and the NATO meetings.
The US nonfarm payrolls data (jobs growth) in May was particularly strong at 211,000 against an expected 190,000. The unemployment rate fell to a very low 4.4%. But, like in Australia and
elsewhere, wages growth is anaemic. After allowing for the modest levels of inflation, the so-called ‘real wage growth’ is all but zero.
The first quarter GDP growth reading was revised up from 0.7% to 1.2% (annualised). The first quarter results are often buffeted by weather factors so this result is not yet considered to be a problem. However, it will limit the Fed’s enthusiasm to hike rates or speed up the shrinking of its balance sheet.
Europe
Macron won the French presidency – as expected. That brought stability to markets in that region. The UK goes to the polls on June 8th in what PM, Theresa May, hopes will be a ticket for her to lead the exit from the EU. However, the early polling is not going well for May. The only real upside for her is that her opposite number, Jeremy Corbyn, does not have much support from Labour politicians. In the UK, the non-parliamentarian members of the Labour Party have a major say in who leads the party.
The Manchester bombing was yet another reminder of the constant source of instability terrorists can wreak on communities. After initially fearing further attacks from the same group, the security level in the UK has since been downgraded by one notch.
But when we focus solely on the economy, Europe continues to strengthen. It is now running ahead of trend growth!

Rest of the World

North Korea launched a missile that reached an altitude of 120 km! The US, and the rest of the world, is increasingly concerned about the proliferation of tests in that part of the world.

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

Economic Update May 2017

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
Global conditions continue to improve
– French presidential elections spark markets
– Trump tax cuts as expected
– Surge in Australian employment
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

The big market rallies that started with Trump’s November election didn’t lose steam in March. But it took the first leg of the French presidential election to get us across the line in late April.

People were naturally worried that France could vote in a “Frexit” president. In round one, Macron and Le Pen made it to contest round two while side-lining the major parties. Macron is very much favoured so that, in a two horse race, he has an excellent (but not certain) chance of becoming president.

Markets surged on the news as they see Macron as steering a steady ship. The days of people expecting a rapidly disintegrating European Union are almost gone.

France is not without its problems. Its economic growth slipped to an unimpressive +0.3% in quarter 1 (Q1). Elsewhere in Europe, Greece celebrated its seventh anniversary of its debt bailout. The IMF (International Monetary Fund) now claims it was stretched by the size of the 2010 bailout.

In April the IMF increased its 2017 growth forecasts: for the UK to 2.0%; and the world to 3.0% from its previous 2.6% forecast. The IMF is not known for its positivity so these forecasts are indeed welcome signs of continued economic life.

The UK is doing quite well in every context. Its PM, Theresa May, called a snap election for June 8th to ensure that there would be ample time for the Brexit negotiations to be completed and digested before the next election. Had she not gone early, there would have been less than a year after the completion of Brexit – as it is expected to pan out. Of course, it helps that the opposition party is in complete disarray at the moment.The US produced mixed results. On an economic front, the results were not great. Employment (nonfarm payrolls) came in at about half of what was expected. However, unemployment came in very low at 4.5%.

US growth came in at +0.7% for Q1 (annualised), the slowest since the GFC. But warm weather arguably affected clothing and heating oil sales. One number is not a problem.

Housing in the US was another story. New home sales and house prices both surged over 5% for the month compared to the same month last year.

On a positive front, Trump announced his tax plan which involves big cuts and simplifications. It didn’t excite markets for two reasons; firstly, it was much as expected; and Secondly, he didn’t announce how he would pay for the cuts.

The biggest surprise of the month came from Australian jobs formation. A massive 75,000 jobs were supposedly created after a year (2016) when full-time jobs actually fell. Unemployment is stuck at 5.9% which is not good by normal standards.

The RBA (Reserve Bank of Australia) does not look like cutting rate. But J.P. Morgan and Macquarie predict two cuts – and we agree that we need these two predicted cuts in 2017. To top that, Scott Morrison at last looks like doing something sensible.

Morrison wants the May Budget to reflect the difference in “good” and “bad” debt. The personal equivalent is an affordable mortgage for your home is good but a loan for a holiday is bad. Does the debt generate something lasting and useful?

This distinction would allow the government to produce a fiscal stimulus without losing sensible management of bad (or recurrent) debt. Game on!

And while all of this has been going on, the VIX fear index and other market volatility measures have been well below average. The ‘old normal’ we have been waiting for since 2007 is here.

Asset Classes

Australian Equities

The ASX 200 had a decent April, up +1.2% to follow a wonderful March of 3.3% – both including dividends. Volatility was particularly low so the market is grinding up slowly. The way we like it!

The big dividend-paying stocks behaved at extremes. Financials stocks – like the big banks – powered ahead at +1.9%, Property at +2.2% and Utilities at +3.1% at one extreme while Telcos were savaged at  9.9%!

There are all sorts of problems going on in the Telco space that makes it unattractive at the moment. The big banks have limited growth prospects but their dividends look sustainable.

With, in our opinion, no property price bubble waiting to burst – risks in banking appear to be ‘as normal’.

Foreign Equities

Wall Street and the German DAX were up about the same as the ASX 200 in April. The London FTSE was down  1.6% on the month but that follows a string of quite good months.

The VIX ‘fear’ index (which is considered by many to be a proxy for investors taking out insurance on downside risk in stock markets) has been consistently low for some time. Even as Trump lobbed missiles into Syria, and North Korea tried to lob theirs further than the launch pad, the fear index was contained. This rally is one that investors are comfortable with.

Bonds and Interest Rates

The RBA did not change rates in April and looks very unlikely to do so in May. J.P. Morgan reiterated its prediction for two cuts for 2017. We agree that the cuts are necessary but the inflation and employment data posted in April might give the RBA a false signal that things are OK here.

The US 

Federal Reserve (Fed) did not alter rates but it did state that it seems the right time to start running down the $4.5 trillion debt built up during the GFC. It is likely that they will just let some short term debt mature without buying more to cancel out maturation as they have been doing. It looks like this process will take a very long time to complete.

Other Assets Iron ore prices fell further – by  17% in April. However, the current price is reasonable for our miners and our export data.

Oil prices slipped about  2% and our dollar matched that fall.

Regional Analysis

Australia The unemployment rate stayed at 5.9% for March and retail sales fell by  0.1%. These are poor data.

In the last couple of years our labour market has been subdued. So the March creation of 75,000 new jobs stands out as an anomaly. These data do have a wide margin of error, coming as they do from small sample surveys. We do not see this number as heralding a new surge in continued job creation.

Inflation jumped up to 2.1% making it lie in the comfort zone of the RBA at 2% – 3%. However, there were extremely big increases in petrol and electricity prices that seem unlikely to be repeated.

We see both inflation and jobs as giving false hope. However, Australia is far from being in dire straits. But someone needs to do something.

The Treasurer has the opportunity to do something useful in the May budget. It looks like he is positioning himself to deliver an infrastructure investment package. That would be great but, given the opposition and cross-benchers, getting bills passed is another matter.

China

China continues to produce strong economic statistics. But what we need from China now is some form of co-ordinated effort to keep North Korea in check.

U.S.A.

The jobs data unexpectedly fell to only 98,000 new jobs from around the 180,000 expected. But unemployment at 4.5% is really quite low meaning that less new jobs are needed compared to when unemployment was recently in double digits.

That GDP growth also came in low, which makes it less likely that the Fed will hike again soon. We think there will be at most one more hike this year – say around August.

US Consumer Confidence fell to 124 – which is a very high number in itself. The previous number was a 16-year high! Americans are happy.

Europe

The French voted as expected for the first round of the presidency election. It seems like Macron will win round two against the left leaning anti-Euro Le Pen.

The problems in Europe continue to recede.

Rest of the World

North Korea launched a couple of missiles that fortunately exploded before they left the test site. The US seems ready and able to deal with North Korea if it continues its belligerent attitude.

On the other hand, the US successfully lobbed 59 missiles from ships in the Mediterranean at Syria. While all forms of warfare have unintended consequences, it does seem that this display of strength not only helps control the terrorist group, ISIS, but also is a demonstration to North Korea of what the US can do.

The US also dropped the largest ever non-nuclear bomb on a remote part of Afghanistan. This too seems to be more of a demonstration of strength to North Korea than an end in itself.

Economic Update April 2017

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

Global conditions continue to improve

– The “Fed” hikes rates but markets liked it

– China continues to impress

– The United Kingdom (UK) manages Brexit well

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

March could have gone either way. We were waiting for: a big rates decision by the US Federal Reserve (“Fed”), Trump’s first bill through Congress on Obamacare; the UK actioning of “Brexit”; and the usual plethora of statistics.

March turned out much better than most expected – particularly for the Australian stock market. Janet Yellen, the Fed chair, must take most of the credit. She played the markets beautifully by talking up – well before the meeting – the number of rate hikes for 2017 and the renewed strength of the economy under Trump.

The market locked in an almost certain March hike. The market had already priced in the hike so that wasn’t taken as a negative signal when she pulled the trigger. And Yellen said at the press conference the hike showed the economy had sufficient strength – but she hosed down notions of more than the three hikes the Fed had flagged after last December’s meeting.

The net result was that markets were very happy because all the recent talk of four or more hikes had gone away. It felt like a rate cut! The United States (US) jobs data were very strong in March and inflation was just under the target rate. A great economic mix!

The Republican Party embarrassed itself by not agreeing on the changes to Obamacare (Affordable Health Care Act). There is a new faction of about 30 Republicans – including the Tea Party members from the Sarah Palin days – that have extreme right-wing views. In short, the so-called ‘Freedom Caucus’ simply disrupted.

Trump handled the defeat well. He just moved on to the next bill which is on tax reform. In some sense that has accelerated the short-term economic plan – and markets liked that too.

Is it not surprising, therefore, that the US recorded its highest consumer confidence reading in 16 years – and it was much, much stronger than the month before. The media are less than kind to Trump but the population obviously loves what he is doing.

China also impressed with a very good manufacturing number, reasonable retail sales, and a target of 6.5% economic growth for 2017. On top of that they recorded the strongest producer price inflation in nine years. That sort of inflation is very good because it measures how much businesses are earning.

The UK has now actioned ‘Article 50’ which means the Brexit must be complete by March 2019. The UK economy jogs along at a brisk pace against the predictions of the many who thought it ‘would mark the end’ for Britain.

Sydney house prices posted another strong quarter making for a very rapid rise since late 2013. However, if we go back a decade further, Sydney house prices were flat or down when compared to the CPI! At one point, the market was down nearly 15% against the CPI from late 2003. The market has just played catch-up.

It is a fact that average house prices usually go through extended periods of stagnation followed by a handful of years of rapid growth. From 2003 to today, Sydney prices have only averaged +2.5% p.a. faster than the CPI. Yes – that makes it harder for people to get into the market. But it is not the stuff of bubbles and property crashes.

In our opinion, the banks are safe from a housing crash so the ASX 200 is safe and the RBA has room to cut rates to help the sagging labour market. So why don’t they? The big banks are starting to raise rates on their own!

One should never rule out markets being side-swiped by some unpredictable event. But conditions seem very stable for the medium term. Market volatility has been unusually low through March.

Asset Classes

Australian Equities

The ASX 200 had a wonderful March gaining around 3.3% on the month including dividends. The ASX easily outperformed Wall Street and London. As such it was playing catch up.

We noted that, towards the end of the month, the ASX had strong days when the lead-in from overseas was weak. The market breached 5,900 for a few minutes on the last day of March. Our January 1 forecast for an end-of-year value of 6,000 is very much on track.

Most sectors performed well in March. The broader index was brought down by Materials, Property and Telcos.

Foreign Equities

Wall Street was flat over March. We take this behaviour as a sign of strength since Wall Street had run so hard since the November 8th election. Strong rallies often end in corrections of 5% or more. So far Wall Street has avoided a correction in this rally.

Indeed, market volatility and the VIX ‘fear’ index have been particularly low in March. We interpret these statistics as pointing to the market simply taking a ‘breather’ rather than marking the end of the ‘Trump rally’.

Bonds and Interest Rates

The market appears to be pricing in one, or possibly two more hikes by the Fed this year. We always doubted the Trump effect bringing actual economic stimulus before 2018 – although we believe it will come. It just takes time to put new policies into action.

The ECB kept rates on hold in March, as did our RBA. That has not stopped some of our banks raising home loan rates for both owner-occupiers and investors alike.

Other Assets

Iron ore prices fell from an unexpected high in February but market commentators are generally confident about prices remaining solid for the rest of the year. Oil prices also slipped but then stabilised.

The Australian dollar was flat over March but moved in a two cents range.

Regional Analysis 

Australia

The unemployment rate jumped up to 5.9% for February but retail sales came in at a respectable +0.4% for the month. We see no government or RBA action on the horizon to improve the situation.

Labor had a resounding victory in the WA elections and the government slipped further in the polls. However, the swings in popularity are not coming from better economic policies to promote growth but negativity about the incumbents’ policies.

China

China really has solidified its position as a strong economy. Some doubted its strategy a year or so ago but pessimists are relatively few and far between these days. It was particularly pleasing that its producer-price inflation was so strong.

Of course there are always political risks when the China economy is being analysed. In particular, it is not clear what Trump will try and enact and recent dealings between China and Australia were slightly destabilising.

U.S.A

The jobs data were again strong with the unemployment rate coming in at 4.7% which some Fed members consider is lower than full employment!

The main risks associated with the USA are related to Trump’s ability to get his bills through Congress. That he has moved across the aisle in an attempt to woo Democrats is essential as long as he cannot rely on his ‘Freedom Caucus’ to vote with the rest of the Republican Party.

That Trump is moving on to tax reform next is important as there is likely to be more agreement across factions on that front. Experts on US TV have put August down as a likely time for putting a tax bill before Congress. However, given the backdrop, the timing of the bill is inherently uncertain.

Europe

The Dutch decided not to vote in a party that favoured leaving the EU. On that same vein, France’s presidential election seems likely to favour the status quo.

Donald Tusk was re-elected as EU Commission president. And the ECB chair, Mario Draghi, has spoken on not needing to loosen monetary policy any further. Indeed, he spoke in terms of one day tightening!

Rest of the World

North Korea continues to be a major worry for us all. Japan wants to up its missile capabilities to counter the North Korea build up.

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

Economic Update March 2017

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
– Trump rally continues on Wall Street. But are equities over-valued?
– China is back in style
– Australian economy struggles
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 The Dow Jones just completed its longest run of consecutive daily gains in about 30 years. But is that good news? Some fear a correction, but there are always some in that camp.

Robert Shiller was awarded the 2013 Nobel Prize for his work on irrational exuberance, or mispricing, in markets – amongst other contributions. So it comes with more force when Shiller wonders whether it is time to take some profits as he voiced in late February.

But Jeremy Siegel, another Ivy League professor, disagrees with Shiller. Siegel claims that Shiller’s pricing index has been elevated for twenty years. He goes on to argue that accounting standards have tightened over the years to the extent that reported earnings are now less than they once would have been for the same underlying conditions – hence the elevated data for 20 years.
So, when we calculate P/E ratios (share price divided by earnings), the ‘E’ for earnings in the denominator is smaller than they would otherwise have been – hence the P/E ratio is bigger. Siegel claims we can’t compare these ratios over a long period of time. He is not worried about current over-pricing.
While mispricing signals may not make for a clear-cut decision, few would argue that the markets have priced in Trump ‘doing something big’. If Trump fails to deliver, markets may correct. If he delivers, markets could march on and on.
Trump is giving almost daily updates of his plans. We are not waiting for one big announcement – rather a body of statements that point to new world order. The reaction to an accumulation of smaller statements is better for market conditions than one big announcement that could make the market go either way – and sharply.
The US economy is looking a lot stronger. But is it strong enough for a rate hike by the US Federal Reserve (the Fed)? The latest growth figure is only +1.9%. This is the slowest recovery (from the Global Recession) since the Great Depression!
The Fed is certainly warming up for one but they are talking in terms of reacting to Trumps tax cuts, infrastructure spends and simplification of regulation. None of these policies have yet been enacted so March seems off the table. Maybe even June is too soon.
However, the market is starting to price in a March hike because of recent Fed chatter. Is this the Fed trying to soften us up for future hikes – or are they for real?
It seems China is set to stimulate again if, indeed it hasn’t already started. Iron ore prices charged higher in February on the back of China’s strength. And that has translated into bigger company profits just reported in Australia.
The China manufacturing number was comfortably above the benchmark for optimism at the start of February and rose during the month.
The problems with our economy are continuing to accumulate. Retail Sales fell by  0.1%; we lost a large number of full-time jobs; and we got the lowest wage growth on record! Economic growth just came in at +1.1% for the quarter – but that is partly on the back of stronger resources.
But the Reserve Bank of Australia seems bent on not cutting rates because of what it might do to Sydney house prices. The longer they wait, the more they will have to cut later.
Australia continues to operate in an economic policy vacuum. The delivery of the May budget seems so far away, and so unlikely to deliver what we need.
Asset Classes
Australian Equities The ASX 200 posted a solid gain of +1.6% in February – but lagged behind Wall Street’s +3.7%. After strong growth in resource stocks on the ASX before February, some of that growth was given back last month.
However, many sectors posted gains of 4%, 5% and 6% in February – including dividends. The swings between which sectors are performing better continue to be large and frequent making funds management that much harder.
The company reporting season for the ASX 200 was largely positive but the few companies that under-delivered were punished harshly. We expect the ASX 200 to make gains in 2017 but not as strong as we see the gains on Wall Street.
Foreign Equities Wall Street backed up a good January with a very strong February. Indeed, all major markets posted good returns for the month.

The Dow posted 12 consecutive days of gains in late February. This run is the longest since 1987! One more day and it would have taken the record back to 1970 and 1929! However many of these gains were small. Indeed, Bloomberg reports the 40-day average of daily movements is at the 1929 low. It is better to watch steady growth rather than bouts of high volatility.

Bonds and Interest Rates US bond rates have maintained their elevated status since Trump was elected. The Fed is talking up rates but we remember the last two years when the Fed only produced one rate hike per year when they had promised more.

The Fed’s current plan is for three hikes in 2017 but the market is pricing in less. If the Fed waits too long it will be hard to rein in inflation, but at this point inflation is not a problem.
The Bank of England kept rates on hold but pushed up its economic growth forecasts. We also kept rates on hold – as did New Zealand.
Other Assets Iron ore prices were up 11% for the month while oil prices were flat. China optimism seems to be the catalyst for the ore price movements while bringing new rigs back into production took the heat out of oil prices.

Gold prices were up +4% and the copper price was down 1%. The Australian dollar was up just over one US cent.
Regional Analysis

Australia

There are increasingly weak signals for the Australian economy but they are being masked by a mini boom in China.

When we strip away the China effect we see negative growth in retail sales, wages and full-time jobs. The policy response seems to be contemplating small cuts in corporate taxes spread out over 10 years and only for small companies.

Both sides of politics are actively considering tax hikes across the likes of superannuation, capital gains and Medibank levies. None of these changes will support our economy.
The GDP growth data for Q4 2016 came in strongly positive at +1.1% taking two consecutive quarters of negative growth off the table. But this jump in growth might not be sustainable. The resources sector played a big role in the last few months with strong volumes and unexpected high commodity prices.

China

China’s Purchasing Managers’ Index (PMI) came in at 51.3 against an expectation of 51.2 at the start of February. A month later and the PMI has risen to 51.6 against an expectation of 51.1 A number above 50 demonstrates optimism.

China’s inflation was up sharply: +6.9% for producers and +2.5% for consumers. Low and negative inflation has been a problem for China so these strong numbers are a welcome relief. Of course we do not want inflation to rise too strongly.

It is widely considered case that China is on a course to further stimulate its economy – and that will benefit Australia’s resources sector.

U.S.A.

The jobs data were the strongest for four months and unemployment, at 4.8%, is around the Fed’s estimate of full-employment.

US Retail Sales were quite impressive at +0.4% for the month and CPI inflation was good. But the Q4 GDP growth figure stayed at +1.9% after the first revision.

We are yet to get a clear view of what Trump is planning but it seems deconstructing Obamacare is to be first followed by tax cuts. We still think it will be close to 2018 before we see policy translating into much stronger US growth.

Europe

The latest news from France is that the Presidential election is less likely to cause the upset that would impinge on the European Union’s strength. But we should not forget Brexit and Trump!

Britain has passed the necessary legislation in the House of Commons to start the Brexit process. So far, there have been none of the negative economic implications so many predicted.

Rest of the World

North Korea remains an issue with its nuclear programme. While many potential problems lurk around the world this is, perhaps, the threat that is the most dangerous.

Julie Bishop is recalling the entire set of ambassadors from over 100 locations to Canberra for a two-day conference. Given the rapidly evolving foreign diplomacy issues – including Trump, South China Seas, and Europe – she wants to refocus our energies and ensure policy is aligned with our needs.

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

Economic Update February 2017

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
– Trump has hit the ground running
– Australian economy is struggling
– China may again save us!

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 fascinating economic experiment is taking place. The only major economy that can reasonably be described as performing strongly is China. The US, UK and a few others are growing modestly. We are certainly in the ‘could do better’ basket for our report card.
After nine years of being stuck in a groove, it didn’t look likely that western economies were going to spring into action anytime soon. But then along came Trump – a non-politician. His promise in simplistic terms was to do something different. He has certainly started off the way he said he would – signing executive order after executive order.
The markets have certainly been inspired in the last three months by Trump’s confidence. Wall Street has repeatedly hit new all-time highs. Even the ASX 200 has witnessed strong growth since the presidential election.
Plenty of people have jobs here and in the US. It’s just that they’re not as well-paying jobs as they used to have – and many more are now part-time. As a result, there is little demand pressure to raise wages or consumer prices.
What are we missing? The business confidence to invest! There are two major factors that determine investment decisions: the potential demand for the output; and the cost of the investments.
There have been no flags waving for potential demand for nine years. So Trump aims to cut corporate taxes to make investing cheaper, and kick start potential demand by flagging big infrastructure projects jointly funded by the public and private sectors. The plan seems to have legs but nothing is certain in this world.
The US economy is starting from a low GDP economic growth number of +1.9%. Not bad but it is the slowest growth since 2011. That’s actually good because it is easier for the next few numbers to show an improvement which, rightly or wrongly, might be attributed to Trump. And if that scenario eventuates, the snowball could gain momentum on business confidence.
The downside is that the snowball could get out of control in a year or two and lead to uncomfortable levels of inflation. The US Federal Reserve must become fleet of foot to raise rates at the right time. Too soon and the impetus might fizzle; too late and they create a big problem in trying to control an overheated economy.
So why is the media and public backlash to Trump so great? Could it be that there are many vocal sore losers than normal? In every election, the opposition person or party also get a lot of votes – just not quite as many as the winner. In Trump’s case, he appealed to the less well-off groups. The educated and/or left leaning media and other disenchanted groups have better access to platforms for debate.
The blue collar workers in the US never had much of a voice – until they put up with an extended period of being worse off – and Trump is their knight in shining armour.
There is a very reasonable chance that the US economy will start to grow strongly again and take the world with it. The UK just posted the best current growth figure of 2.0% in western economies.
Australia should benefit from a strong China and US. Commodity prices might be supported, or even grow, but we can’t live off resources forever. At some point we have to restructure our economy. We need tax cuts and infrastructure programmes like Trump. All we seem to have on offer from either side of politics are promises of tax hikes. Of course, in the short run, the deficit would increase but from good (infrastructure) debt – not bad (recurrent) debt.
Asset Classes
Australian Equities
The ASX 200 looked set to post a modest gain for January but it faltered in the last couple of days of January. But after the previous three months, a breather is perhaps welcome.
The resources sectors, Energy and Materials saved the day for us. Iron ore and copper prices made good gains on optimism about China. Australian resources companies are widely tipped to perform well in the upcoming February reporting season.
In the month before reporting – known as the ‘confession season’ – a number of companies experienced sharp prices movements – up or down – on the slightest of unexpected news.
Companies like Bellamy and Brambles lost more than 10% in one day on their share prices. Perhaps less well publicised were the big gains – like CSL, and Resmed.
The forward guidance given by companies in reporting season will not really have had time to have benefited from assessing any Trump-led impact. We’ll have to wait for that.
Australian banks did really well in Q4 of 2016 but stumbled in January as investors realised that prices had run too hard. Unlike in the US, there is not a lot of change in the wings to help this sector. But dividends look largely safe and growth may come later.
Foreign Equities
Wall Street enjoyed a good January. The Dow Jones index broke through 20,000 and stuck for a couple of days. All four major indexes hit all-time highs on the same day!
The London FTSE staged a massive rally of consecutive daily gains. Brexit does not seem to be worrying UK investors.
We continue to think overseas markets will have a better 2017 than the ASX 200. Nevertheless, diversification across domestic and international markets is still wise
Bonds and Interest Rates
There should be little doubt that global rates are on the way up. The question is – how quickly? We think less so than many commentators because we think it will take time to put expansionary plans into action. And, of course at home, we still need cuts.
Macquarie Group reaffirmed its call for two rate cuts at home on 2017 but the consensus is for rates on hold until 2018.
Other Assets
Certain commodity prices (like iron ore and copper) continued to strengthen in January and our dollar (against the US) appreciated. Oil prices were down slightly but are well up on this time a year ago.
Regional Analysis
Australia
Our employment data released in January did nothing to dispel the feeling that our economy continues to struggle. Full-time employment was down -34,000 jobs on the year when maybe +100,000 jobs were needed to allow for population increases.
The Bureau of Statistics pointed out that the annual change in total employment (including part-timers) was less than half of the average over the last twenty years.
Our inflation read missed expectations on the downside. Perhaps the only bright spot was data on resources trade which might save our bacon for the next GDP read.
China
China continues to post solid economic data. China even raised interest rates on 6 and 12 month loans to slow down its economy!
The latest Retail Sales figure was +1.9%, which was ahead of expectations, and economic growth was on target at +6.7%. The IMF upgraded its China GDP forecasts to +6.5% from the +6.2% forecast published last October.
U.S.A.
No one can be sure what Trump is really planning but the ‘old political system’ certainly was ‘broke’. Some of his executive actions seem over the top but, perhaps, he needs everyone to sit and take notice. The world needs a new dawn and nobody before has solved the problem.
All of the early short-term indicators point to an energised US economy. True – there are many unhappy folk – but Trump has surrounded himself with people who were mega-successful in their own rights – and not just a bunch of people getting the nod for services rendered.
Europe
The doomsayers again got caught out. The UK is not a disaster in a Brexit world. Indeed its economic growth in Q4 2016 was better than any other country in the Western World.
There were thoughts by some that a Brexit mentality would sweep Europe and cause chaos. That didn’t happen either.
Rest of the World
Trump’s temporary ban on travel from certain Middle Eastern and African countries to the USA causes angst among many – but the main ban is only scheduled to last for 90 days.
North Korea is still huffing and puffing over its nuclear programme. That’s too difficult a problem to assess in an economic update.

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