Economic Update

By Ron Brewley*. Brought to you by Infocus

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

Federal Reserve dictates market moves:

– US Fed unlikely to rock the boat
– Australian economic growth shows positive signs
– China bears submit

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 

In December 2015, the United States (US) Federal Reserve (Fed) hiked rates for the first time in nearly a decade. At that time they predicted four more hikes during 2016, so far there have been none!

Some held out hope for a hike in September, but this group have been disappointed at each meeting. December this year is their last chance for 2016 they might just do it to save face but there is no legitimate reason.

After two years of solid job growth, 2016 has been a fizzer so far. New jobs are positive, but about 25% down on 2015 data. The new Fed economic growth forecasts are 2% for each of the next two years – and then 1.8% for 2019.

Central Banks raise rates to slow growth and curb inflation. US growth is at best moderate, inflation is anaemic and wage growth is on life support. We think that there will be at most three rate hikes before 2019. There is just no case for chancing the impact of more hikes than that.

If the Fed does as we think, stock markets will have another couple of good years. But what about Australia? World markets have done well while we have limped along.

Our economy posted strong growth for the second quarter of 2016. Over the year our economy grew at 3.3% and that’s better than moderate! On top of that we note a turnaround in what households have to spend after inflation and after allowing for population changes. After four bad years of growth in that indicator, the latest number was strong.

But the labour force data is still not out of the woods. The basic issue is that part-time jobs have been growing quite nicely but the full-time jobs are down on the year to date. As a result, the unemployment rate appears to be better than it is.

The Reserve Bank of Australia (RBA) kept rates on hold in September at 1.5%. With six central banks having negative rates, and the Fed rate only a bit above zero, our 1.5% is quite large by international standards.

Dr Philip Lowe took over the governor’s position at the RBA in September. There is no urgent need for a cut at home and so the new governor might not want to start his career with a cut. But we think we will get at least one more over the next few months.

September got a boost near the end of the month after what looks like OPEC might strike a deal on cutting the supply of oil which may impact oil prices. But Deutsche Bank dominated the close of the month.

There is talk that Germany might have to support its huge international bank to pay a fine to the US for GFC events. A few hedge funds have withdrawn some of their business so that caused a little volatility.

But will it turn into a big problem? That doesn’t look likely at this stage. Angela Merkel goes to the polls next year and her party suffered some big losses this year over the refugee immigration policy. She has to support the bank if need be. And a rumour has surfaced that Deutsche has cut a good deal with the US.

With the US recently publishing its best consumer confidence read in nine years, its citizens either think they know who will win the presidential election in November or they don’t care who wins.

The world economy continues to improve – albeit slowly. The doomsayers have gone into hibernation for the northern winter – the China bears are asleep.

Asset Classes

Australian Equities

The ASX 200 did end a long losing run in September but it is still up +3.9% for the current financial year to date (FY16). A lot of that gain is due to the Materials sector gaining +11%, Consumer Staples +11% and Financials +4%.

However, for the calendar year to date, the so-called ‘yield sectors’ (Financials, Property, Telcos and Utilities) have lost ground wiping out the dividends received. The other sectors have been going gangbusters.

We see plenty of opportunity for good fund managers to end FY16 on a high note however the broader index might struggle to get through 6,000.

Foreign Equities

Wall Street is off its all-time August highs, but not by much, it is largely trading sideways. The London FTSE shows no sign of struggling after the July Brexit referendum. The Shanghai Composite market is also largely trading sideways.

The world seems to be waiting for a signal for the next leg up in markets but volatility measures suggest there is no imminent downturn from known sources – and, by definition, no one can predict the unknown!

Bonds and Interest Rates 

Central bank activity, or lack thereof, held the markets’ attention again during September. It looks like low rates will continue for longer than most thought at the beginning of 2016.

There is an obvious split in the Fed decision makers. One or two say that they are already behind the curve, there is some support for no rate hikes before 2018!

The Bank of Japan (BoJ) kept rates on hold in September but pledged to do some more on stimulating its economy using less transparent means. Markets responded well to this.

None of these rate forecasts make it any easier for retirees who choose to rely on term deposits and government bonds.

Other Assets 

Oil prices jumped up after OPEC made a preliminary statement about cutting supply. The decision will be put before a formal OPEC meeting in November. Oil prices are currently sitting arround 75% above the low of 2016.

Iron ore prices seem to have stabilised at just under $60 / tonne which is about 40% up from their lows of 2016.

The VIX ‘fear’ index that measures expected volatility on Wall Street is down about 50% from the 2016 high.

In other words – as we tried to explain earlier in the year – commodity and stock markets were going through a temporary but painful wobble. The longer term looked fine then, which is consistent with the outlook now.

Regional Analysis

Australia

Our headline unemployment rate fell to 5.6% however this figure is misleading because of the continuing switch from full time to part time work.

Economic growth reported last month was strong and if that continues we would expect some real improvement in the labour force statistics.

Our business and consumer confidence indexes were up in the month however business conditions fell.

China

The emphasis has moved away from watching China statistics, because broad opinion is that the Chinese economy has settled.

The main problems with China relate to its position over territorial claims in the South China Seas. China is moving positively on ratifying global warming action.

U.S.A.

Anyone – other than possibly US voters – watching the lead up to the November presidential elections on TV must be amazed by the goings on. It makes the Sarah Palin era look tame.

Clearly there are strong negative views about both candidates. We think that we should not dismiss the chance that Trump will win. He may not have typical presidential credentials but the world is changing. Large numbers of people in many western countries are getting fed up with how they are being governed. People are looking for change without necessarily considering the full consequences.

Markets prefer Clinton as shown by the reaction to the first debate. But there are more votes in the Mid-West, the Deep South and elsewhere than in Manhattan. The US people will choose who they want.

If Clinton wins markets could rally into Christmas. If Trump wins there might be a little volatility but the president can do little without Congress being onside. Just look at Obama’s lack of success in getting his way over the last eight years.

Europe

The United Kingdom (UK) continues to shine in the sunlight after Brexit. Its Purchasing Managers Index (PMI) came in well above 50. The new Prime Minister, Theresa May, announced a $16 bn improvement of Heathrow. More countries need good infrastructure spending – Australia included.

Europe is slowly dealing with the refugee situation. M. Hollande, the French President, seems committed to dismantling the Calais ‘jungle’ camp. The backlash against the German political policies makes it more likely that all European Union (EU) governments will want to act to resolve the situation without too much downside for the general population.

Rest of the World

Iran declined to deal with OPEC over supply cuts but the next day OPEC stated that it was going to move anyway. Japan’s data shows no signs yet that suggest further stimulus will not be provided.

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

Important information

This information is the opinion of Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management and may contain general advice that does not take into account the investment objectives, financial situation or needs of any person. Before making an investment decision, readers need to consider whether this information is appropriate to their circumstances.

Economic Update

By Ron Bewley*. Brought to you by Infocus

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

With Brexit fears cast aside:

– United Kingdom (UK) confidence bounces back

– United States (US) Federal Reserve claims economy strengthening

– Japan ready to add more 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 your Financial Adviser.

The Big Picture

It is just a year since some reports on the China stock market sell-off last August predicted doom and gloom. As we suggested at the time, it wasn’t a major problem because that market was, and is, in its infancy. The market stabilised and it is now comfortably above those 2015 lows.

At the end of 2015, some nerves were rattled about the prospects of Federal Reserve rate hikes in the US. While occasional bouts of uncertainty continue to cloud market movements, the successive Fed meetings have gone reasonably smoothly.

In January 2016, the Royal Bank of Scotland told us to ‘Sell everything’ and some other big houses made similar dire predictions. Markets are comfortably up and selling wasn’t the answer.

Oil and iron ore prices dived in February 2016. Iron ore prices dipped below $40 but later climbed to $70. Oil was predicted by some to get down to $20, or even $10, when it was $26. Instead, prices have more or less doubled. Another ‘crisis’ averted!

And then there was ‘Brexit’, and the dire predictions that went with it. The ‘leave’ vote won, but consumer confidence jumped 3% in the UK in the first month following the referendum. Markets are stable and the pundits got it wrong again.

Of course, at some point, an event will come along that will have a medium-term adverse impact on our investments, but most of these stories are simply overblown in quiet news periods. At this point we feel that all of those ‘scare stories’ are fading into oblivion and there are no new major known issues brewing.

At home, our labour force data isn’t great, but the mid-year fall in full-time employment seems to have turned around. Unemployment is stable at 5.7%. Our Reserve Bank is expected to cut rates again – from 1.75% to 1.50% sometime this year – but that is more to align our rate with the rest of the world rather than a reaction to avert major issues at home.

News in August was dominated by the Olympics. Australia was disappointed but ‘Team GB’ beat all expectations. There are big lessons for economic management to be learnt from these results.

Australian Olympic success was at a low in Seoul, 1988. Government funding was pumped in with increasing success to match – until, that is, at Beijing and after.

Great Britain (GB) hit its nadir in 1996 at Atlanta, with only one gold medal being won. The national lottery was born with substantial taxes going to sports’ funding.

In both cases it took time for athletes to respond, but pumping money into a venture alone is not an investment. Just like with migrants, the expression “The first generation makes it, the second builds on it, and the third loses it” might apply to economies and sports alike. But our athletes might now be doing as well – it’s just that others are rapidly improving.

Importantly, Australia was reported to have concentrated funding on our traditional sports. GB, on the other hand, looked for opportunities in sports they had not previously been good at. GB’s plan seems to have thrown up many unexpected successes.

The reaction to the GFC was for governments to cut back on fiscal spending around the world. Now we need well-tailored programmes to start the next phases of growth. Not pink batts, but spending on considered infrastructure projects and the like could be what we need now. But with our government system living on minority leadership for too many years, it is difficult to see from where such a programme will come.

In the meantime, growth might be a little below par but good enough. A shot in the arm for infrastructure could well be the start for a return to our desired long-run growth path.

Asset Classes

Australian Equities

The ASX 200 did lose  2.3% in August, but that followed a massive +6.3% gain in July. Virtually all sectors lost ground in August but market volatility remains reasonably low.

After reporting season in August our view of the fundamentals remains strong, we expect the 2016/17 financial year to be strong. The calendar year-to-date for 2016 posted a gain of +5.6% including dividends.

The high-yield sectors of Financials, Property, Telcos and Utilities continued to seriously lag behind the other sectors in 2016 y-t-d including dividends. Indeed, capital losses in high-yield have more than wiped out dividend payouts. The total returns of the ‘other’ sectors have exceeded +14% y-t-d.

Foreign Equities

Wall Street hit some new all-time highs in August. The VIX fear index reached quite low levels suggesting markets are quite settled even if August was not a strong month for markets.

With a rate hike in the US unlikely before December, only the Presidential election seems likely to interfere with a smooth finish into the end of 2016.

Bonds and Interest Rates

The RBA kept rates on hold again in Australia. The Fed Reserve’s second-in-command caused some volatility with his comments, shortly after Chair Yellen made her views known. While Yellen saw the chance of a hike strengthening with good economic data, Fischer went further putting September back on the table. December is still our call for the first hike.

Other Assets 

Oil prices have seemingly stabilised on talks between OPEC and Russia. At current prices, oil is too cheap to warrant shale oil to come back on stream in the US and too high to cause major concerns going forward.

The VIX volatility – or fear – index reached a low for 2016 during August. Our dollar did vary somewhat over the month but the change on the month was relatively small.

Regional Analysis

Australia 

On the face of it our employment data grew strongly, but full-time employment fell while part-time employment did the work. The unemployment rate was steady at 5.7%.

Trend full-time employment – the official preferred method – has started to pick up – possibly because of the earlier rate cut.

China

The month started reasonably well with the Purchasing Managers Index (PMI) at 49.5 for manufacturing – which is just below the break-even 50 level. The services version of the PMI continues to be well above 50 as the domestic economy takes over from infrastructure expenditure.Mid-month retail sales and industrial production did miss forecasts by a fraction but not enough to worry markets.

U.S.A. 

Janet Yellen talked up the strengthening US economy at the annual Central Bankers’ conference in Jackson Hole. There is no doubt that employment data has bounced back strongly from the earlier mini-slump. But two good numbers are not enough to eradicate all discomfort.

Europe 

The Brexit vote won at the end of July. August Retail Sales surged at +1.4% against an expected +0.1%. UK confidence also surged from a three year low to 109.8 from 106.6. With Olympic success as well, it seems the UK has side-stepped the issues that some worried about earlier in the year.The Bank of England did cut its rate at the start of August and also pumped in some unexpected monetary stimulus.

Germany’s GDP came in at +0.4% for the quarter smashing expectations. There are also other pockets of mild success. Brexit will happen slowly so trade deals can be renegotiated far before trade becomes an issue.

Rest of the World 

Japan can’t win a trick, as they just recorded another month of deflation. Japan is pledging to continue to stimulate the economy as required.Japan’s problem is its falling population. Many countries, such as ours, would also look a little glum if populations were not growing!

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

Important information

This information is the opinion of Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management and may contain general advice that does not take into account the investment objectives, financial situation or needs of any person. Before making an investment decision, readers need to consider whether this information is appropriate to their circumstances.

The Big Picture

Brexit – or the referendum to decide Britain’s future in the EU – dominated news up until the vote on June 23rd and then swamped it. The polls were always close – and there were only two possible outcomes – ‘exit’ or ‘remain’. But for some reason, markets and the British people were stunned when the ‘exit’ vote got up.

If we allow for the 72% turnout (voting was not compulsory) ‘exit’ scored 37% of the vote, ‘remain’ 35% and the ‘no vote’ was 28% – so it was a close run race. But Boris Johnson – the lead MP for ‘Brexiting’ – looked a bit like a frightened rabbit when he won. Indeed, he has now dropped out of the race to be the next PM!

Current British PM, David Cameron, went into hiding after announcing he would stand down by October and the leader of the opposition, Jeremy Corbyn is in trouble with half of his shadow ministry resigning because they claim he didn’t lobby hard enough to ‘remain’. And then 80% of his party gave him a vote of no confidence – but he won’t stand down, yet. There are now rumours of replacing the Governor of the Bank of England because of his views on Europe. The England soccer coach got sacked a couple of days after Brexit because his team lost to Iceland in Euro 2016! Nobody seems to have won! But leadership issues are not confined to Britain.

There is a chance that Parliament, who must sanction the vote for an exit to be enacted, might not take that next step and Germany is even looking like it might try to woo Britain back in.

The main downside for Britain is that London might lose its status as a major financial centre. In time, Europeans, who now freely work in Britain, might have to go home and vice versa. But it will take years for the whole process to unravel – perhaps a decade.

In the meantime stock markets have taken big hits but our ASX 200 seems to have done relatively well. Losses have largely been erased.

Of course, at home, we not only have Brexit to deal with. We have our own election on July 2nd, a possible rate cut on July 5th and the US jobs report on July 8th.

The US Fed seems to have walked away from a rate hike anytime soon – as we have been predicting for months. One cut in December is a far cry from the Fed’s four this year that they predicted last December – but it makes sense to wait.

Brexit may play a role in the Fed’s thinking but the last jobs number of +38,000, when +160,000 was expected, demonstrates a hike now would not be prudent.

Our jobs data were quite well received but we still see some weakness in full-time employment. Yes, there were +17,900 new jobs, but all were part-time. There were zero new full-time jobs, making January the last increased trend in full-time jobs!

But there are some good points. The European Central Bank did raise its growth forecast for 2016 – from 1.3% to 1.4%, and the Spanish general election the Sunday after Brexit, resulted in an increased majority for the ruling People’s party. This has been taken as a statement of conservatism after Brexit. That is, there was no swing to more radical parties that might want to follow Britain out of the EU.

By the way, Brexit is nothing like Lehman Brothers and the GFC. It’s not even as bad as the Greek debt crisis. Maybe more like the Blues losing the State of Origin series again (for those south of the border)!

Asset Classes

Australian Equities

After three consecutive months of strong gains, the ASX 200 had a negative month in June largely owing to the ‘Brexit’ referendum.

The losses were largely across-the-board with only Property and Utilities – two very defensive sectors – making gains in June. Stocks with possible exposure to Britain were hit particularly hard. The likes of BT Funds Management, Clydesdale Bank (a NAB offshoot) and Macquarie Bank were savaged.

The financial year (FY16) that just ended finished up +0.6% when dividends are included. However, that doesn’t tell the whole story. In FY16, the Industrials, Consumer Discretionary, Health, Property and Utilities sectors were all up between +20% and +25%. It’s just that Energy (???21.7%) and Financials (???8.7%) were hit hard.

We have the market slightly underpriced and the fundamentals look strong for FY17. It’s just a case of what temporary shocks buffet us along the way.

Foreign Equities

Market carnage hit most countries. The German DAX lost over ???6% on the day following Brexit. But a couple of days later most markets rebounded. Wall Street finished flat on the month and the London FTSE was up +4.4%. The German DAX was down ???5.7% showing that Germany might miss Britain more than the other way round!

The VIX ‘fear index’ jumped up sharply following Brexit but it has already settled down to below average.

Bonds and Interest Rates

The RBA was on hold again in June at 1.75%. Brexit may have changed the RBA’s thinking but we believe either way, one or two cuts would help us a lot.

The US Fed removed the phrase, “in the coming months” regarding the next hike in its press releases. Almost everyone takes that to mean there will be no hike soon. We think December is the earliest.

Bond yields have fallen in post-Brexit times. The German government yields are now on average negative!

The Bank of England has flagged the possibility of increasing stimulus – either by a rate cut or asset purchases – in the remainder of this year.

Russia cut its prime rate from 11% to 10.5%. And Japanese PM, Shinzo Abe, has urged his central bank to do what it takes to get through this bout of volatility.

S&P cut its rating of UK government debt to AA (negative watch) from AAA. It also cut the EU debt to AA from AA???. But remember the US lost its AAA rating a few years ago with no lasting backlash.

Other Assets

Iron ore prices have been amazingly stable given the global events but oil prices took a bit of a hit after Brexit. However, prices have now more or less recovered. Of course, oil is a far more speculative market than iron ore.

Our dollar has moved around a lot in June finishing the month up +2.5% against the US dollar. Normally we focus on the $A against the $US but, with Brexit around, the $A against sterling moved up well over 10% in the day or two following.

Gold rose strongly over the month, up +8.8%.

Regional Analysis

Australia

News on the economy has taken a back seat while we try to work out what the political adversaries are offering us. A big ticket item is superannuation and both sides have been less than forthcoming about the details of what they are proposing. Serious analysis we have done shows that politicians and public servants will be much better off than those in the private sector – whichever side wins. Nests have been feathered!

In a disturbing run of labour force data, the unemployment rate has held at a moderate rate of 5.7% but that is because an increasing numbers of ‘workers’ are part-time rather than full-time. Of course it is better to have some sort of job – maybe 10 hours – than no job at all, but that is not the basis of a growing economy. Full-time employment has fallen in each of the last four months in trend terms!

China

For a change, China is off the radar. All the doomsayers are in hiding or gainfully employed following Europe instead. It is clear that all of the data from China is consistent with it being an economy we don’t have to worry about.

BHP just announced a +29% increase in expenditure on mining exploration – up to $900m for 2017. It is also rumoured that they are thinking of bidding for the second largest fertilizer mine in the world – which happens to be in Canada. Of course BHP had been cutting back in previous years but this is a very positive sign for the resources sector.

U.S.A

Watching Trump v Clinton, Turnbull v Shorten and ‘Exit v Remain’ it is clear that the political order has changed. We can’t imagine enough people being content after the November presidential elections that there won’t be another bout of volatility then, if not before.

But the fundamentals of the US economy are not bad. They are just not great.

Europe

Britain is still in the continent of Europe if not the EU – at least not soon. Britain’s economy is one of the stronger in the region but it is not clear what will unfold in coming months.

There has been talk that France might also want a referendum to see whether it should stay in the EU. Spain voted conservatively in its election this week just gone. Frankly it is too soon to form a confident view of the world order. But the chances are there is more bluster than substance.

Rest of the World

Iceland deservedly bundled England out of Euro 2016 (soccer competition like a world cup for Europe). England left Europe twice in a few days! But Brexit could mean a lot of European footballers in the prestigious English Premier League have to go back home and be replaced by English players. The EPL football might not be then as good but the national team might do better (they couldn’t do worse).

The main Turkey airport in Istanbul was the subject of a major terrorist attack. It has been argued that the fear of Turkey joining the EU with the free movement of people was a major factor in people voting for Brexit.