Economic Update

Economic Update – August 2016

The Big Picture

Our stock market just posted the best month since October 2011! The ASX 200 rose +6.3% in July and we were near the head of the pack of the major world indexes. Since +6.3% is about the average for a year, this turnaround story shows how easy it is to miss out for investors who keep jumping in and out of markets.

But there was no really good news to spark this world-wide rally. Rather, it was the settling of the dust on a number of key issues that had been on the back burner. All the fuss about Brexit turned out to be nothing more than a distraction.

The United States (US) jobs data ended a very poor run for 2016 with a bumper number for June. The US Federal Reserve was at least seen as probably not hiking rates for the remainder of 2016.

But the best bit must have been the China data. GDP growth, Industrial Production and Retail Sales all did quite well – but Bloomberg released its new China index. The China Premier – before he took office – often spoke about how to make China data more transparent. He wanted to focus on things like electricity demand – which is easily measured.

It turns out that the new Bloomberg index does just what the Premier wished for and suggests that the China data agency, if anything, has probably been understating growth in its GDP releases.

If it hadn’t been for the Bastille Day massacre in Nice, this would have been time to pop the corks of some chilled bubbly. And, sadly, Nice wasn’t the only tragedy in July.

Turkey nearly sent markets alight with a mid-month military coup. It started after the market closed in the US on a Friday and was all over in time for Sunday lunch. Markets opened just fine on the Monday.

Of course this does not mean bad news will never recur. But with markets gaining strength, the VIX ‘fear index’ is at a very low level indeed; the US Q2 company reporting season has been quite good and ours starts in a few days.

We have the market fundamentals quite strong and much of the recent rally merely eroded underpricing from undue pessimism. We are now back on track for the forecasts we posted at the start of 2016.

There has been lots of talk about rate changes and stimulus around the world but it seems central banks are moving slowly in measured steps. There is a good chance that the RBA will cut in August – but if it doesn’t, it will probably cut soon. Our unemployment rate of 5.8% is neither good nor bad. It is more a problem, of who would prefer full-time to part-time employment.

Our full-time employment situation stopped deteriorating this month. The next number should tell us whether the May cut by the RBA had some impact.

And, of course, we had a general election with no clear decision. But neither was there daylight in the Brexit vote and it seems close between Trump and Clinton. Perhaps it’s time for a real set of leaders to step into the ring.

Our electoral problems probably contributed to Stand & Poor’s putting our nation – and our big four banks – on negative credit watch. It’s not a big issue if we lose our AAA status. Remember the USA lost its AAA rating a few years ago.

Asset Classes

Australian Equities

No sector on the ASX 200 went backwards in July and we would have had an impressive five-month run had the ‘Brexit month’ of June not turned out to be  2.7%, but folded into the impressive +6.3% for July. We have had +14% growth in the ASX 200 since February.

The banking sector has been holding the market back for some time. Those in search of yield seem to be flocking into Property and Utilities stocks – plus a bit in the low-yield, but highly defensive, Heath-care sector.

Foreign Equities

All of the major world indexes had a great July. The S&P 500 and the Dow recorded several all-time highs on Wall Street.

Wall Street was helped by some good company reports in July. A few of the banks did particularly well and Amazon blasted out of the blocks.

With the S&P 500 at 2,174, Citi’s forecasts for End-of-Year 2016 of 2,150 is already behind the 8-ball – but they are sticking to it!

Bonds and Interest Rates

The RBA was on hold again in July at 1.75%. The market was pricing in a 70% chance of a cut on August 2nd but that probability fell to 55% straight after the low – but on expectations – inflation figure of 1.0% for the year.

The US Fed claims September is a ‘live’ meeting for a possible rate hike. Most analysts are thinking December to June 2017 is far more likely.

European Union debt was downgraded to AA- from AA by Standard & Poor’s.

Japan under-delivered on its expected stimulus package this month.

Other Assets

After a terrible start to the year, iron ore prices recovered to sustainable levels and up +12% in July. Oil prices too recovered but lost over  14% in July.

Oil rigs in Alberta are coming back on line after being closed in the big fires of 2016. That should keep a lid on oil price increases.

Gold (+2.1%) was up on the month.

Regional Analysis

Australia

First quarter inflation came in at a negative rate, so it was with some relief that a modest +1.0% for the year was posted in Q2. Since the RBA ‘target band’ is 2% to 3% ‘over the cycle’, they have a reason to cut rates – particularly since the employment data is stubbornly very ordinary.

China

The chatter about China facing a hard landing has faded into the background. China has room to move but economic growth is strong.

U.S.A

While the jobs data were stellar last month, they are still not enough to soak up the slack for the weak start to 2016. These key data need to be watched particularly as US growth disappointed in Q2.

Analysts were expecting 2.5% (annualised) but got only +1.2%. To make matters worse, Q1 growth was revised downwards from +1.1% to +0.8%.

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

Europe

The European Union economies continue to be sluggish and the impact of terrorism on prospects is hard to ignore.

People on both sides seem to be handling the Brexit solution well. There is no reason to expect a sudden fracture in their relations.

And if Britain needed a dose of confidence, in one weekend they won two Wimbledon titles (Murray and Watson), the British Grand Prix (Hamilton), and 1-2-3 in the Tour de France (Froome, Yates, Martin). General Classification and Mark Cavendish had already won three stages and wore yellow. Who said a country couldn’t come back from the brink? All they need now is a football team.

Rest of the World

Japan Prime Minister Abe scored a landslide victory in his Upper House. That enabled him to pass through a massive fiscal stimulus package – but the Bank of Japan didn’t do as much as expected on the monetary stimulus side.

Brazil’s economy is in real trouble and Olympic success seems far from being a done deal. Venezuela is putting forced labour to work on farms. While we focus on some parts of the world, South America and Africa – as well as parts of the Middle East – are faring far short of what they would hope for.

Economic Update – July 2016

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.

Breaking up is hard to do – the Brexit

By Ron Bewley*. Brought to you by Infocus

History and the vote

When Neil Sedaka had his 1962 hit “Breaking up is hard to do” it was only four years after the signing of the Treaty of Rome – from where the European Union (EU) was born. France strongly objected to Britain joining for many years which was the catalyst for many boys in secondary schools across England (including moi) to question why they had to learn French.

So with Brexit winning the referendum on Thursday, did Britain get what it wanted or needs? We thought the bookies would have got it right with a ‘Remain’ win. Even Boris Johnson (Tory MP and former Lord Mayor of London) and Nigel Farage (MP and Leader of the UKIP party) – the two most prominent “Brexiteers” – didn’t think they would make it on the morning of the referendum – but they did. With the vote at about 48% : 52% and a total casting vote of about 70% (voting is not compulsory in Britain), the people who didn’t vote came in a very close third in the race: 33.6% = 70% x 48% for ‘Remain’; 36.4 = 70% x 52% for ‘Brexit’; and 30% = 100% – 70% didn’t vote)!!

This was not a resounding victory but it was enough to start the exiting process.

Many of us were glued to the telly all day on that Friday, June 24th. Our reaction changed markedly as the results flowed in. Our first reaction was unrest because the consequences of leaving hadn’t really been discussed in the media. But we felt calmer as the day progressed. The shock subsided.

So why did Europe want Britain to stay as much as they implored? They must be getting a better deal than Britain! If they trade with Britain now, why wouldn’t they want British goods when they are ‘sans Europe’?

Changes ahead

Of course Britain may stop making Airbus wings in North Wales which then have to navigate canals, the River Dee, the Irish Sea and the English Channel and more canals to be delivered to Toulouse and stuck on the bodies of planes. But Britain won’t have to subsidise all of those small farmers any longer in France, Greece and elsewhere. Britain won’t have to pay for our euro MPs to live on the gravy train in Brussels. It is a nontrivial problem to solve and the answer is not known by anyone – yet!

The Bank of England and the European Central Bank have stated they will pour oil on any troubled financial waters. This is certainly not a Lehman Brothers or GFC type event. It is also clear that it will take up to two years for Britain just to exit Europe – it doesn’t change straight away. Indeed, the full transition to renegotiate trade deals could take up to a decade.

So what are the pros and cons? On the downside, the biggest risk is what will happen to London as a financial centre. That could be a big down-side and it could also affect Australian banks in their funding (yes – we borrow from the world and not the RBA for home loans so that’s why mortgage rates shouldn’t simply shadow the RBA rate).

But Britain will no longer be told how to regulate its economy by Europe. A Cornish pasty can once again be ‘crimped’ on the top and not just the side to be properly classified as a “Cornish” pasty. And they can again grow any variety of apples they want! They can even take control of the style of sausages they make and sell!

Continental Europeans freely working in Britain may have to go home. Economic refugees in Britain would not as easily get government benefits. Britain can regain control of its borders. People will have to show their passports to travel and get visas to work – just as young Australians do who work in Britain now and vice versa.

Australia has recently made important bilateral trade deals with the likes of China. It can now make some with Britain without having to convince the other 27 counties that the same rules should apply to them. For example, one deal with Europe was recently scuppered because the Italians didn’t like our proposed anti-dumping laws for their tinned tomatoes.

Domino effect

But who will be the next cab off the rank? Britain joined the then European Economic Community (EEC) when there were just a handful of countries “in Europe” – then some peripheral countries joined – then the far eastern, poorer European countries such as Bulgaria and Romania joined in 2007.

We don’t think Britain would ever have joined if there was a common currency and 27 other countries. The current EU is so different from its forerunners and is largely led by Germany – and to some extent France – and Brussels.

The EU has a common currency, the euro, across 19 of the 28 countries but no common fiscal policy. That is, unlike in Australia where Canberra controls much of taxing and spending across the separate states, 28 governments in the EU have no strict common goals. Hence, we got problems with Greece and its debt problems. Greece couldn’t devalue, as it used to without leaving the euro and the EU subsidies it gets.

Scotland is now talking about having a second bite at being a separate nation after Brexit. Scotland largely voted to ‘Remain’ in Europe – as did the south east of England – but the more working class north of England swamped the ‘Remain’ votes in the single aggregated British vote.

And there has been talk of a referendum to decide where, if anywhere, should be the border between the Republic of Ireland and Northern Ireland (in the UK).

Denmark and others who are not in the common currency but in the EU might be watching closely. If Britain starts to look better off, why wouldn’t they follow suit?

The EU morphed into a grab-bag of unlikely bedfellows. The initial reason for making the union was almost certainly to give Germany and France a voice on the world stage. But they needed to add some chums to make it seem like a real union. Shades of 1989 and the falling of the Berlin Wall are now so close.

Stock markets

Markets usually over-react and they probably have done so this time. It looks like there will be big buying opportunities ahead but not in our banks until we better know what will happen in that space.

We couldn’t help but notice that the falls on the ASX 200, the London FTSE and the S&P 500 on Friday were all around ???3.5%. But over the week the ASX 200 was only down ???1.0%. We got a bit ahead of ourselves in predicting a ‘Remain’ and then unravelling some positive momentum.

The London FTSE was actually up +2.0% for the week even after Friday’s big sell-off! The S&P 500 on Wall Street was down only ???1.6% for the week.

The Frankfurt Dax was only down ???0.8% for the week after tumbling over ???6% on Friday night.

With our SPI futures (an indicator of how the ASX 200 is likely to open on Monday as it is traded overnight) up +3 pts for Monday, it is possible order could quickly return to markets.

Football (soccer)

England lives to fight another day in the Euro 2016 football competition. England faces the mighty Iceland at 5am on Tuesday in the last 16. England has only played them once before and England won 6-1. But has Iceland improved or did the other teams just capitulate in the group stage matches? We hadn’t really thought of Iceland as being in Europe. Are they in the EU? No! And Australia entered Eurovision and we are certainly not in Europe.

But if England gets through, it will probably meet France in the quarters – and in the unlikely event England progresses to the semis, it then faces its arch-rival in football, Germany. For England to possibly face France and Germany only days after Brexit, the mettle of these footballers will surely be tested.

What to watch for

Simply watching the finance news on TV might not give you the information you really need. The media has a seeming predisposition to focus on bad news and draw a long bow when connecting some events.

The end of the financial year on June 30th usually brings with it some extra temporary volatility on our stock market as fund managers ‘window dress’ their portfolios to look as good as possible for reporting purposes.

Our general election on July 2nd could cause some volatility in its own right depending on how the voting goes. A hung parliament is the worst result. Our government – of whichever political flavour – needs the power to enact good economic policy.

The Reserve Bank of Australia deliberates on interest rate settings on July 5th. It might cut rates. It might change its interpretation of how the economy is travelling. So more volatility is possible!

On July 14th (Bastille Day!), our June Labour Force data will be released by the Australian Bureau of Statistics. The recent trend in full-time employment has been falling to the extent that changes in f/t employment have been negative for four consecutive months.

No one really seems to be talking about this – except us at Infocus for the last few months – so if we get another fall and it gets picked up? You’ve guessed it – more volatility.

And in August most listed companies on the stock exchange report their final or half-year results. Since companies must give guidance about changes in performance, many companies upgrade their prospects in July – the so-called ‘confession season’.

Conclusions

Even without Brexit we would expect a few weeks of heightened uncertainty in our markets. The fundamentals are quite strong – but not brilliant. We anticipate looking back on June and July later in the year as another blip but no more.

The UK Prime Minister has flagged he will leave office in a couple of months and Boris Johnson (aka BoJo), the enigmatic former Mayor of London with a hair style akin to Donald Trump, will probably succeed. He is a very smart, charismatic man (BoJo not Trump) who is likely to steer Britain through change as good as anyone could.

We need to watch for any of the big international banks, like Morgan Stanley and Deutsche, to see if they feel a need to relocate some of their offices, etc.

And at home, the only likely downside to the Brexit seems to be an impact of funding for our banks. Perhaps we can strengthen our relationship with Britain. That should not stop us continuing to have good relations with continental Europe.

Of course, dual citizens (Australian and Continental European) might be less able to go and work in Britain. But plenty of Americans holiday in Britain each year without being EU members.

So it’s time to take a deep breath, put the kettle on and have a cuppa to settle the nerves – just as they are probably doing across Britain right now.

*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 – June 2016

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

Economic Update – May 2016

The Big Picture

April witnessed further strong gains on share markets. These gains were helped by commodity prices rallying hard. Iron ore prices rose around +20% in April making the gain from December’s $38 to April’s $70 peak impressive indeed. Brent Oil gained about +24% in April!

So why did these commodity prices gain so much? Well, China restocked its steel inventories causing a 50% plus gain in China steel prices this year. Some of this restocking was due to more stimulus spending by the Chinese government but some was just a natural part of the cycle.

Saudi Arabia seemingly failed in the Doha talks to get an OPEC/Russia deal to stabilise prices. But Saudi Arabia then went on to make a massive policy statement on Anzac Day to create a new economy that is far less dependent on oil revenue. This latter action has seemingly supported oil prices.

At home there was some slightly worrying economic news. Inflation for the March quarter came in at ???0.2% when +0.2% was expected. The annual figure was +1.3% against the expected +1.7%. Since the Reserve Bank’s (RBA) target range is +2% to +3% ‘over the cycle’ we are not yet in trouble but an interest rate cut is now far more likely.

The Labour Force survey showed that the unemployment rate fell to 5.7% but the underlying trend data did not improve. Indeed, the trend employment data disappointed for the first time in more than a year. Full-time employment is now growing at 0%! A second reason for a cut! Indeed, the market is now factoring in an imminent cut at home despite the political implications.

China data came in strongly over the month. Exports were up +18.7% over the year; GDP came in at +6.7% and both Retail Sales and Industrial Output beat expectations. The China manufacturing Purchasing Managers’ Index (PMI) just came in above the all-important 50 at 50.1.

There is so much news set to drop over this and the coming week or two that we will be a lot wiser in a couple of weeks. Our Budget and its associated forecasts have revealed a number of changes in addition to the RBA which reduced rates by 25 basis points to 1.75%. The all-important US jobs data are due on Friday May 6th.

And we should not underestimate the possible ramifications of a June 23rd ‘Brexit’ referendum to decide Britain’s future role in Europe. And throw in an election for us on July 2nd.

The US Federal Reserve meeting at the end of April did not announce a rate hike as expected despite Chair Yellen repeatedly saying it was a ‘live’ meeting. Importantly Yellen removed the previous comment about global risks but added that the US economy was showing some signs of a slowdown. Indeed, the latest economic growth figure released after the meeting for quarter one was a very disappointing +0.5% (annualised).

April’s release of the March jobs data showed a solid but modest increase of 215,000 new jobs with a slight increase in the unemployment rate to 5.0%.

So in conclusion, there is a little extra economic uncertainty around at the moment but, when the dust settles, we are looking at steadily but not strongly growing markets and economies.

Asset Classes

Australian Equities

The ASX 200 had a splendid month gaining +3.3% on the back of +4.1% in March. That still leaves it down ???0.8% on the year-to-date but up +0.5% if we include reinvested dividends.

The Materials sector gained a massive +14.2% in April on the back of surging iron ore prices – now up 50.0% for the year-to-date. Energy wasn’t far behind at +7.6% for April as oil prices too have been very strong. Brent Oil is up + 32.1% year-to-date. The big problem has been the big banks. Not only have they continued to collect criticism over their behaviour, there is widespread speculation that dividend policy will change. The Finance sector was up only +1.4% for April.

We are expecting a bout of volatility with the coming Budget and interest rate decisions here and overseas but that volatility could take us up rather than down!

Foreign Equities

The S&P 500 only gained +0.3% in April but they had a stellar March at +6.6%. The index has been flirting with all-time highs making some investors nervous – until they break through it!

The VIX ‘fear’ index has drifted back to average levels after a period at well-below average levels.

Bonds and Interest Rates

The Bank of Ireland issued a 100 year bond at 2.35%. That means there are sufficient people prepared to lock in a low rate of inflation for 100 years as the fixed rate of return needs to be above inflation to compensate investors for risk. Strange times indeed!

The RBA unsurprisingly kept its rate on hold again in April but there was increasing support for an imminent cut after the latest inflation read. The RBA delivered that cut on the 3rd May and the market then rallied hard.

The US Fed did not hike its rate in April and analysts are divided between no hikes and up to two hikes this year. We do not see an imminent hike but one is possible around December or early next year. June is possible but the proximity of the November elections and the weakening US economy should keep the Fed on hold.

The oil giant ExxonMobil lost its AAA credit rating from S&P for the first time since the Great Depression. Naturally, a number of smaller oil companies are facing stressed credit views.

Other Assets

Iron ore prices were up +20% over the month after the previous month’s +10%. The price has already fallen about $6 / tonne from the April peak of over $70.

Oil prices too have continued growth and Brent Oil was up about +24% on the month.

The price of gold was up +5% but both UBS and Macquarie suggest that peak gold prices for 2016 have already been made.

Regional Analysis

Australia

Turnbull seems to have lost his ascendency in politics but the Budget might change that. Consumer confidence has waned and someone has to take the reins. The Budget is critical.

Amazingly, the soft Labour Force data went largely unnoticed but the inflation data did grab attention. We don’t know how much steel will be used in building the new Franco-Australian submarines but surely it can’t support an entire industry.

The headline unemployment rate was fine at 5.7% but remember that was just about the peak in the GFC!!! Inflation is in the doldrums and the last economic growth figures were nothing to write home about. We are far from bad but good seems so far away. We need a government in control.

China

China started the month with a target range of 6.5% – 7.0% for economic growth rather than a single figure such as the previous target of 7.0%. Well, they nailed it at 6.7% and a plethora of other good statistics. Some analysts still complained.

So if, as we firmly believe, the so-called hard landing has been well and truly avoided, what next? Less volatility on China data? More optimism on world growth? We can’t be sure but the worst seems to be well behind us and most now agree.

U.S.A

The US is becoming a scary place as the Presidential election approaches. Trump with his Mexican Wall and Muslim bans is one thing (not nice) but Clinton is now wagging fingers at China over trade policies.

China, like the US, Australia, Europe etc., might occasionally do the wrong thing but nobody normally wags a finger in high office – they use diplomacy. The US will not come out of 2016 well. It seems like the US is on a slippery slope.

Donald Trump, the US Presidential hopeful predicted a ‘massive recession’ for the US this year. Dr Bernanke, the former US Fed Chair and of this world, said in a special meeting with the last four Fed Chairs that a recession has a small chance of occurring in any year and 2016 was no more likely than 2015 or 2014. We are in the same camp as these exalted and eminently qualified public servants.

The latest growth data were a little low but most are expecting a rebound in the second quarter. Jobs data continues to be strong.

Europe

Europe is on the brink of a major rethink as the UK holds its referendum on whether or not it should stay in the European Union. President Obama ‘happened’ to turn up in London to meet the Queen and the Prime Minister. That’s all fine but is he now a lobbyist for the ‘stay in Europe’ vote?

The immigration problem seems to have stabilised – to some extent – but much of the Brexit problems are over the free movement of people into the UK to take up public housing and benefits with no qualification period. They seemingly believe real refugees should be happy to be settled in France (where numerous UK people go for nice holidays) rather than try to enter Britain illegally on the back of a truck from Calais. Cameron did win many concessions on points such as this so the call could be close.

Nobody can reasonably predict what will actually happen if the UK leaves the Union. But there are reports that three EU countries might consider their options if Britain does exit the EU.

Rest of the World

North Korea continues to flex its missile muscles. Iran refused to go to the Doha OPEC meeting on April 17th to discuss supply controls.

Japan had strongly been hinting at providing more stimulus but then disappointed markets at the end of the month by holding firm.

Economic Update – April 2016

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.

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