The Big Picture

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

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

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

Foreign Equities

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

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

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

Bonds and Interest Rates

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

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

Other Assets

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

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

Regional Analysis

Australia

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

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

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

China

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

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

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

U.S.A

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

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

Europe

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

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

Rest of the World

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

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

Foreign Equities

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

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

Bonds and Interest Rates

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

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

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

Other Assets

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

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

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

Regional Analysis

Australia

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

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

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

China

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

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

U.S.A

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

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

Europe

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

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

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

Rest of the World

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

The Big Picture

Last month we tried to leave you with the view that the stock market machinations were not really connected to any particular market view of economic fundamentals. A month later and markets moved even lower before they started to recover towards the end of February.

Iron ore prices rose to over $51 / tonne from $38 in December. Oil prices are well above the lows of January/February. And while no one is suggesting commodity markets are heading higher and higher, the panic attack at the start of the year seems to be well behind us.

But then we got a new spruiker in town during February predicting a 50% fall in property prices in Australia! We won’t name them because you have probably never heard of them and almost certainly won’t again. Every few years we get such attention seekers. Presumably they are selling (or short selling?) something. We think they have no credibility in the profession.

But just for fun let’s assume prices fell by 50% as ‘predicted’. That would take prices back to GFC levels when a different spruiker was then predicting a 40% fall. And so it goes on.

Prices only fall significantly when people are forced to sell at a loss. Australians by and large have jobs and seem unlikely to lose them. Many have big offset accounts for their mortgages and others are simply well ahead on payments. Of course individual properties or pockets of properties may lose value for a variety of reasons – but not the average.

What is fascinating at home is the recent mooted change to Senate election process. You may recall we argued after the last election something had to change in this regard to provide for a stable government with a strong economy. Well it looks like voters will now have to state whom their preferences are to be distributed rather than the old under-the-table deals by the parties that produced the motley crew of senators we got last time.

Turnbull seems to have swept everything off the table that was recently on it – including a possible hike in the GST. A good conspiracy theory we could start is that the likely double dissolution on July 2nd was always the main game. The government may have ‘sucked in’ the opposition to announce alarmist policies on negative gearing and tax increases – to give the government greater ammunition to sweep into power in both houses. And then new tax policies could be launched in the next term. Makes far more sense than a 50% fall in house prices!

Our economy is still doing quite well but with a functioning government (of either party) devoid of irritations from senators most didn’t know they were voting for 2017 and beyond, which could be really, really good.

But wait. There’s more! The US elections are heating up. It looks like Trump versus Clinton in the November presidential elections. Clinton frightens Wall Street because of her views on healthcare and Trump has stated he will tax Wall Street! One report that doesn’t seem to have attracted enough attention is that Michael Bloomberg – the former New York mayor– said he would run for president if “circumstances warranted it”.

If Trump gets the Republican nomination, might Bloomberg run and win? That sounds like a preferable scenario for markets, the US and us.

And in the rest of the world? The G-20 meetings in Shanghai last weekend didn’t produce a statement of any substance – but they did decide not to organise a co-ordinated global stimulus package. That’s good news. We just don’t need such a package!

Asset Classes

Australian Equities

As we said at the time, the ASX 200 was very oversold earlier in 2016. Most companies reported earnings during February and, by large, they were quite strong. Of course Slater & Gordon, BHP and some others are not in that group but there was a sizeable number of share prices that jumped 5% – 10% and more on the news of their earnings’ results. Investors had been pricing in the worst and so dived back in to buy when those fears became unfounded.

In spite of recent rallies we still have the market well under-priced. We have fair value at 5,300 and an end-of-2016 well on its way towards 6,000. The February close was 4,881.

Interestingly, there were several trading days in late February when we had a good ‘lead’ from Wall Street and/or started the day well only for the market to fizzle near the end. Trading volumes have been strong so investors in Australia aren’t yet buying the international story.

The banks have been heavily sold off. Some argue this is in part due to Sovereign Wealth Funds (Norway, Saudi Arabia and elsewhere) selling off equities to generate cash to keep government budgets under control while oil prices are depressed.

Also, the issuance of bank ‘Hybrids’ with attractive coupons may have added to the sell-off. With expected share yields at 6.7% plus franking credits, some of the big banks’ shares could look very attractive for investors wanting yield. While equity yields are far from guaranteed, it does not seem likely that further capital raisings to satisfy the regulators (as during last year) will be needed this year – and future capital requirements will likely be introduced more slowly than in last year.

Foreign Equities

Markets around the world were quite volatile but the VIX ‘Fear Index’ did not reach the highs of last year – nor during the European crises and GFC. In short, the VIX measures market activity in taking out insurance against future market falls – called put options. The market is not fearful and the current VIX read is not much above average levels as of the end of February!

But our market lost ???2.5% in February while the S&P 500 lost only ???0.4%. London lost only ???0.2% but Germany was down ???3.1%.

Bonds and Interest Rates

The prospect of Central Bank negative interest rates in a number of major countries did frighten the market as no one really knows what the full implications could be. But the US Fed considering negative rates was just that. Prudent regulation requires them to consider their options but their economy is far too strong for that to actually happen.

At home, it is quite possible that the RBA will cut rates once or twice this year. It is not that our economy is struggling that much but with five countries/regions having negative rates – and others having very low rates – the question has to be asked what benefit we get from holding at 2%.

Other Assets

Iron ore and oil prices have risen well above their recent lows. And while a big rally in either is unlikely it is reasonable to predict some further modest increases from here.

There have been some casualties from the recent price volatility. Saudi Arabia had its credit rating cut from A+ to A-; Exxon Mobil had its rating cut for the first time since the Great Depression; Royal Dutch Shell let 10,000 workers go; and BHP had to end its dividend policy with a sharp cut in dividends. This shake out should help support oil prices.

Regional Analysis

Australia

The last jobs data release was another in a long line of solid results but some commentators again missed the point in their quest to generate ‘news’. Trend unemployment remains under 6.0% (having fallen from 5.9% to 5.8% over the last month) and wages growth was reasonable.

But our ‘CAPEX’ (Capital Expectations) data on investment decisions and intentions were weak. Some analysts who were predicting the Reserve Bank of Australia (RBA) would be on hold this year have now moved to the one or two rate-cuts camp.

Consumer and Business Confidence data have softened a little – suggesting the Turnbull honeymoon is over. However, as clarity about the election, tax policy and the budget emerges confidence could be quickly restored.

China

China’s currency received a lot of attention from markets but our RBA Governor stated that he was surprised at the reaction because it was what he expected.

The manufacturing side of China remains softer than the services side as the government wants. It did place $US25bn into the financial system to keep liquidity at reasonable levels. It also cut the Reserve Requirements Ratio for banks for the fifth time in a year by 0.5% to 17%.

U.S.A

The US ended February with unexpectedly strong data on growth and inflation. Importantly, the Federal Reserve formally stated that it believes full employment corresponds to 4.9% and that was the outcome for January – and with solid employment growth. So with employment strong and inflation returning, that’s just what the Dr (Yellen) ordered!

As a result, the market has increased the chance of a rate hike this year from close to zero up to nearly 40% for a June hike. However, there is no rush so March seems off the table.

Of course new data are being released on a frequent basis and views will evolve. But just remember it was only a few weeks ago some commentators were calling for a rate cut in the US – even possibly to negative levels! That is why investors – rather than traders, spruikers and media commentators – need to watch calmly from a distance. Investors seek to increase wealth over the long run. The others make their ‘fortunes’ often during the day! Jumping at shadows can destroy an investor’s wealth.

So what happened to all of the commentators a few weeks ago predicting a US recession sometime soon? We think they’ve all gone into hiding!

Europe

German economic growth surprised on the upside and the UK retail sales surged +2.2% for the month – more than three times the expected rate. But EU inflation did fall back just into negative territory.

The ‘Brexit’ (Britain’s possible exit from the European Union) discussions were very prominent. David Cameron, the UK PM, seemingly came away with what he wanted.

Britain is desperate to change the freedom of labour movement rules – especially in the light of the recent migration problems that drain its social service benefits. It also wants to keep its own currency – rather than join the euro – indefinitely. A referendum on Brexit is slated for June 23rd.

Cameron is coming under fire from within his own divided party. He has said that he won’t stand for re-election and the ‘hot money’ is now on Boris Johnson (now being referred to in some quarters as ‘BoJo’) – the eccentric Tory MP and Lord Mayor of London – to be the next British PM.

Rest of the World

Japan’s economic growth came in even worse than expected at ???1.4%. North Korea ‘tested’ a ‘satellite launcher’ which was interpreted by everyone else as a test for a ballistic missile. Not to be outdone, China launched a surface-to-air missile in the disputed man-made islands in the South China Seas.

Saudi Arabia, Russia, Qatar and Venezuela got together to talk oil supply. They agreed to keep production at January levels but Iran immediately complained because it is only just getting back on stream after a lengthy ban from sanctions over its nuclear programme. Of course putting supply on hold does not necessarily lift prices – but it might stabilise them. A cut in supply seems unlikely anytime soon.

*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

The hope many of us felt for markets on New Year’s Eve dissipated in the first week. But January ended so strongly here, Wall Street and elsewhere. So what is going on?

It was largely an accidental coincidence of several things that separately may have had little impact. The economic questions were around China (its stock market, currency and economic growth); US economic growth; oil prices; and interest rate expectations. Each of those is worthy of much consideration but, on top of those issues a number of other events muddied the waters: North Korea’s nuclear testing; IS terrorism; Iran’s sanctions being cleared; Saudi Arabia and Iran over executions; and attacks on the embassy in Tehran.

And the elephant in the room was the length and stability of the multi-year bull-run on Wall Street. Some were expecting a correction just because they hadn’t had one for ages. With that sentiment, markets can easily overshoot when innocuous missiles are thrown at markets. Well they’ve now had that correction so we can move on!

Let’s start with China. Growth has been questioned in some quarters but China just announced not only a strong month for iron ore imports, but a record! RIO backed this up with Q4 iron ore shipments up 11%. Treasury Wines share price went through the roof when it reported its increased exports to China.

China growth will hopefully continue to fall gradually as they move from a government-funded infrastructure economy to more of a capitalist economy like ours. All developed countries have been through periods like China is now experiencing.

Of course their stock market being closed twice in one week because of sharp price movements didn’t help the uninitiated – but the explanation was so simple. The market was closed the first day ‘circuit breaker’ rules were introduced for the first time ever. Everyone admits that the rules were too sensitive and caused the market falls rather than helping market stability. Those rules were quickly shelved.

And the China currency? They are moving from being pegged to the US dollar to a system referencing a basket of the currencies of its major trading partners. The problem here was China not communicating its strategy well enough, rather than doing something people shouldn’t like.

US economic growth just came in at 2.4% for 2015 and +0.7% for Q4. Their unemployment rate is 5.0% which is just a tenth above what the Federal Reserve (Fed) considers full employment to be. Calls for a recession any time soon seem to be the results of underemployed analysts trying to establish a profile for themselves.

And oil? The real experts acknowledge that a sustainable price for oil is around $50 – $60 / barrel. Any higher and shale oil in the US will be back on stream; any lower and countries go bankrupt. But OPEC has been playing games with the US over shale oil and speculators have been exacerbating the situation.

When Brent oil got down to $26 in late January, some were calling for $10 of Brent oil – a fall of around a further  60%. In a few days Brent jumped up over +30%!

But the Fed has been caught out on interest rate hikes. They predicted four hikes during 2016 at their last press conference but markets are pricing in none or one. There is no rush.

For those of you coming back from a good long summer holiday – welcome back – you didn’t miss anything important on the markets – just froth and over-reaction!

Asset Classes

Australian Equities

The ASX 200 was down  5.5% in January after being up +2.5% in December. But this turbulence was not like that last August. Back then the market fell on statistics like the VIX fear index were, which was much worse than that in January. Resource stocks and Financials bore the brunt of the negativity in January but no sector improved by more than +1.0%.

Importantly, our indicators of potential long-run capital gains improved over the month. We have the market under-priced by about  6% so there could be some strong gains sometime soon.

Reporting season by listed companies is about to start. Since a number of downgrades have been reported in resources and retail stocks, much of the bad news is behind us.

Foreign Equities

Our market, although down, performed well compared with many of the big overseas markets. The world index was down  7.8%.

China’s “Shanghai Composite” index continued to lose ground as the heavy gearing encouraged by the government in late 2014 and in 2015 was unwound.

The China regulator brought in ‘circuit breakers’ that closed the market for 15 minutes if the index fell by  5% and closed it for the rest of the day if the index fell by  7%. These limits were far too tight for a volatile index like the Composite. The more stable US market only gets closed for the day if its index falls  20%.

Arguably, the introduction of the circuit breakers for the first time ever in January caused the shutdown on day one and the next. When the breakers were removed the market settled down.

Bonds and Interest Rates

Japan spiced up the cash market at the end of January by flagging negative interest rates, more monetary stimulus and a prediction of 2% inflation in two years after decades of deflation.

The Fed suggested last December that it might hike rates four times in 2016 (March, June, September and December) but the market doesn’t believe them. It seems more like one or none. There is no need to rush increases and the last thing anyone would want is for the Fed to hike rates and then be forced to reverse the decision in an untimely fashion.

At home the RBA did not meet in January. The odds of a cut this year are falling but one cut is still possible. Inflation did pop up a bit in the last read so the RBA might want to wait a few months to assess the situation before acting.

Other Assets

Iron ore and oil prices seemed to have stabilised – at least for the moment. There is talk of co-operation between Russia and OPEC over supply limits but, apparently, enacting such a move would be difficult for technical reasons. With Iran being allowed to export oil again after nuclear-related sanctions, there is downward pressure on oil prices. Brent oil was up +15% on the month!

Iron ore prices have been above and below $40 / tonne during January. Vale, the big Brazilian miner, is reportedly having difficulties with pricing and that might help Australian miners.

A number of other commodity prices bounced back at the end of January. Was January just the month we had to have to shake out the cobwebs?

Regional Analysis

Australia

Our jobs data remained strong – against market expectations. It is now over a year since unemployment peaked at 6.3%. Jobs growth continues to be solid.

We are fast approaching the budget and the government is, as is usual, airing some options to test market sentiment. Some are questioning our AAA rating. As we have been writing since the May 2014 budget, we do have a serious problem to tackle. We are not currently in trouble but we will be if we do not start doing the right thing soon.

China

China’s GDP growth for 2015 came in at +6.9% just short of the target +7%. China has announced that its target growth rate is now 6.5% to 7.0%. Its trade data were much, much better than expected.

The China Purchasing Managers Index (PMI) for manufacturing at 49.4 shows that the industry expects continuing strong growth but at a slightly lower rate (as the PMI is below 50). The PMI for services at 53.5 shows continuing expected strong growth but at a more rapid rate.

U.S.A.

Following the December rate hike – the first in nearly a decade, US jobs data came in particularly strongly. Unemployment is only 5.0% compared with the Fed’s estimate of full employment being 4.9%.

The latest GDP growth data did come in a bit softer than the quarter before but more or less on expectations.

The Presidential election, set for November, is hotting up. The usual smear campaigns are starting on both sides.

Europe

Sweden is considering sending a significant number of refugees back and others are seeking to claim expenses for settlement back from the ‘asylum seekers’.

Angela Merkel – the German leader – has suffered in popularity following her desire to take in an almost unlimited inflow, and has had her previously massive support cut to about 40%. She has now stated she expects most to return home when the troubles end. With the huge death toll in Damascus from bombings overnight, that end doesn’t like coming any time soon.

The ECB is still on the case regarding monetary policy. Europe is healing – but slowly.

Rest of the World

Japan lost its Treasurer in a scandal but that hasn’t stopped the policy machine from seeking new ways of supporting the economy.

New Zealand kept its rate on hold but it is considering further cuts.

Russia is hurting and is seemingly trying to gain support in oil prices. But, apparently, the nature of the frozen terrain in Siberia means that if they do cut back supply from there, it will be lost forever. As a result, this month’s meeting between OPEC and Russia is limited in what it might achieve – but, perhaps, talking is a useful start.

Nigeria has just sought a $US3.5bn international loan to support its budget while oil prices for its major export are depressed.

The Big Picture

We were forced to wait 50 weeks in 2015 for the Federal Reserve to hike its key interest rate for the first time in nine years. The angst was so great over 2015 since, at this time last year, there was talk of the first hike occurring last March or at least last June. But those months came and went – and so did September!

The problem with the September meeting was not only that they did they not raise rates as most had expected but the Fed confused all by showing their concerns over global economic conditions. So it was a relief when the rate was finally raised by 0.25% in mid-December with no adverse reaction.

But the damage had already been done. Our market all but reached 6,000 in March from 5,400 this time last year, only to fall to nearly 4,900 near the end of 2015. Then Santa took control and swiftly helped the ASX 200 rise back above 5,300 to finish the year only about 100 points down for the year. Of course investors in our market would also have collected dividends and franking credits of about +6.3% which is very good when compared to holding cash – even allowing for the ???2.1% ‘paper’ capital loss on the price index.

It would be unfair to blame all of the mid-year volatility on the Fed. Oil prices fell sharply because OPEC took on the might of the US shale oil producers. By holding up traditional oil supply, they made the shale oil alternative marginal at best. But the Saudis seemed to have miscalculated the ease with which one can switch shale oil supply on and off. As a result, Saudi Arabia has now found itself with a material government budget deficit problem – and they now intend to hike petrol prices at home by 50% to help rectify the situation. That’s called irony!

Iron ore prices too collapsed – again largely because of an over-supply problem. The ‘Big Three’ producers deliberately put the squeeze on higher cost, smaller mines.

Whether or not ore and oil prices have bottomed is disputable but almost no one of note is predicting prices to rise substantially in 2016. But with the resources sector falling from 36% of our index at the end of 2010 to 16% now, iron ore and oil prices are increasingly less important for an Australian index investor!

At home the big banks came under the spotlight as they were forced by the regulator to improve their balance sheets, to be better able to withstand any future home price corrections. They did this by issuing more shares through ‘rights issues’ which naturally depressed prices. No major additional raisings are expected for at least the next few years.

So the main things to watch for in 2016 are interest rate changes at home and in the US. The Fed published its forecasts which point to four hikes of 0.25% in 2016 while the market is pricing in only two! This disconnect is likely to lead to some short bouts of volatility around Fed meetings.

At home, the Reserve Bank is now thought less likely to continue to cut rates in 2016. There is a chance of one more cut but no one of note is expecting any hikes in 2016.

Market fundamentals are largely fine but it will take some time for investors to feel confident. We are predicting above average returns for both the ASX 200 and the S&P 500 – but nothing stellar. Bond markets might take some buffeting as Central Banks around the world change, or do not change rates.

So our view of 2016 is much like that of a patient just having left the dentist. The build-up was worrying, the treatment not too bad – and now the novocaine is wearing off – with dental health having been restored.

Asset Classes

Australian Equities

The ASX 200 was up +2.5% in December with a strong ‘Santa’ rally from December 15th. Much of the market volatility and ‘fear’ are subsiding. Energy was one of only two sectors to lose but that loss was a massive ???7.5%. Industrials also fell, but only by ???1.2%. The two standout performers were Consumer Discretionary and Consumer Staples at near +7% each for December.

For the year, the capital loss on the index was ???2.1% but, with dividends, the total return was +2.6%. Even with dividends, Energy and Materials lost ???27.3% and ???15.7%, respectively, over the year. But five of the eleven sectors (Industrials, Discretionary, Health Property and Utilities) produced double digit gains.

Since the big four banks, BHP, RIO and Telstra didn’t make the cut for big gains, simple big-cap portfolios didn’t fare very well. But there was plenty of room for nimble fund managers to outperform.

Our forecast for 2016 is for a capital gain of about +11.5% and a dividend of just under 5%. We think breaching 6,000 is quite possible but we don’t think above 6,000 is achievable for long in 2016. We also believe that the ASX 200 is reasonably priced – unlike the US which we think is a little cheap.

Foreign Equities

While out index was up +2.5% in December, most other major indexes were well down: S&P 500 ???1.8%; FTSE ???1.8%, DAX ???5.6%, World ???1.1% and Emerging Markets ???1.5%. These results support our view that our market was particularly oversold in November.

Over the year there was no strong pattern with the German DAX up +9.6% and Emerging Markets down ???8.2% with Wall Street almost flat at ???0.7% for the S&P 500.

Our forecasts for the S&P 500 are for gains of 15% in 2016, we currently have that market under-priced by ???3.3%.

Bonds and Interest Rates

The RBA kept rates on hold again at 2.0% and the next meeting is in February. There is a modest chance of another cut in the first half of 2016 but the chance of a rate hike is minimal for 2016.

The Fed US rate (range) is now 0.25% to 0.50% and the official forecasts are for that range to rise by 1% in four moves (one each quarter) by the end of 2016.

Of course 1.25% to 1.50% is still a very low rate but markets might question the need for so many hikes when inflation is well contained and economic growth is moderate.

The UK seems to have put its thoughts for a hike on the back-burner for now.

Other Assets

Iron ore prices fell from around $70 / tonne to less than $40 over 2015. While they could fall further there does seem to be a bottom forming. But no one of note is expecting big gains in the price during 2016 – a moderate gain to $50 is certainly not out of the question.

S&P downgraded its oil price forecast last January by 30% to $55 for 2015 and by 23% for 2016 to $65. The price has already dipped below $40! There is a limit to how far prices can fall as they are not sustainable at below cost. So if prices have not yet bottomed they don’t seem to have much further to go.

Iran is slowly letting new supply onto the market after having been allowed back to play in the sandpit after sanctions were lifted. This new supply, and OPECs reticence to curb its supply, does not make a significant price hike likely during 2016. Of course consumers are better off from low petrol prices so there are some winners around.

Gold lost over ???10%, and our dollar fell around nine US cents against the US dollar over 2015.

Regional Analysis

Australia

Our economy is moderately strong and inflation is low. Unemployment and employment growth have been steady for much of 2015. The budget in the coming May looks to be in need of addressing our burgeoning debt problem.

It looks increasing likely that the government will go early to the people with some new strong policies. With the opposition down in the polls an early election might rid us of the dysfunctional government we have enjoyed since 2008 – and for the better.

The labour force data showed that +71,400 jobs were created in November and unemployment fell to 5.8%. Although these numbers are very strong, the underlying official trend numbers are improving at a far more modest rate.

The Mid Year Economic and Forecast Outlook (MYEFO) statement by Treasurer Morrison shaved a little off growth forecasts but Treasury is still predicting 2.75% growth in 2016/17.

China

China’s Purchasing Managers Index (PMI) for Manufacturing came in at 49.7 which is the fifth successive month below 50 which signals that, although growth is strong near 7% pa, growth rates are slipping a fraction. China announced more fiscal and monetary stimulus in December.

U.S.A

It follows from the rate hike that the Fed thinks the economy can withstand it. Nonfarm payrolls data reported +211,000 new jobs and unemployment is at 5.0%. This situation is quite close to full employment.

Of course the big problem in the US is the prospect of Donald Trump winning the Republican nomination for November’s Presidential election. Trump has massive popular support but his policies seem to centre on there being less problems if everyone carried a gun (even in Paris, he has reportedly suggested!) and the US rids itself of Muslims. And this man, if he becomes President has his finger on the button in the role as Commander-in-Chief! Trump is not moderate.

But economic growth continues to be stable in the US – the latest data being +2.0% for Q3, 2015. Inflation is well under control. US house prices rose by +5.2% in October from the corresponding month in the previous year. This gain is a far cry from the deflation experienced in 2006 and onwards.

Europe

The economy is showing some signs of life. Industrial Output was up +0.6% on the month. But there have been a million migrants crossing into Europe during 2015. Angela Merkel refuses to put a limit on how many migrants Germany will take. Apparently when Bosnians took that route, two families were each allocated to a myriad of small towns – and assimilation was quickly achieved.

Only half of the one million migrants into Europe during 2016 were from Syria and 20% were from Afghanistan. 98 per cent arrived by sea. 3,600 died in the process. While a humanitarian approach must be taken, just having a million a year swelling the EU population is not the answer.

After the Paris and Brussels terrorist activity, there seems to be a better internationally co-ordinated attempt to solve the problem. That can’t come too quickly.

Rest of the World

Although its economy is still struggling, Japan chose not to add to its stimulus packages in December. Russia could be looking at a recession in 2016 and the Azerbaijani ‘manat’, its currency, lost 49% of its value on one day in December! There are so many problems around the world but they seem unlikely to have any great impact on our investment decisions – unless, that is, you choose to invest heavily in Emerging Markets.

*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.