Economic Update

The Big Picture

After two quite bad months on world stock markets, October produced strong results largely based on comments from the US Federal Reserve.

Fed members were on overdrive at the end of September and the beginning of October, to tell all who would listen, that it still plans to lift its interest rate in 2015 for the first time since 2006.

The October Fed meeting produced a statement which dropped the controversial comments about concerns for global growth and volatility. It also upgraded its description of US growth prospects from modest to solid. It is reasonable to conjecture that, had the Fed used those words in September, we would not have seen the big sell-off at the end of September.

The provisional US annual growth figure for Q3 came in at a low +1.5% compared with the twice revised figure of +3.9% for Q2. There does seem a recent tendency for the customary monthly revisions to growth estimates to raise the estimate, so +1.5% on its own is not a problem.

But US jobs data has been a bit softer in the last two months. The next number scheduled to be released on November 6th needs to be back above +240,000 new jobs – the average over the last year or two – to completely calm nerves on this front.

China just cut its benchmark interest rate for the sixth time since November 2014. It is clearly prepared to manage its economy as the other major countries do. Its economic growth came in at +6.9% which was slightly above expectations. Its export data were much stronger than expected.

With iron ore prices falling again in October, BHP and RIO tabled their quarterly results and both produced much stronger production and shipment data. China is still buying, but it is just at a lower price because of the increased supply by the major miners.

China has been flexing its muscles in the South China Seas around its new artificial islands and sovereignty over the waters around them. The US ended the month by sending in a US Navy ship to show that traffic in that busy shipping lane should not be hindered.

General Secretary Xi Jinping visited both the US and the UK in what seems to have been a very successful tour. China has also signed a trade agreement with Australia and the benefits of trade with the UK are already apparent. Going forward, every London cab will have an electric motor made in China, and China and the UK have signed a nuclear agreement. We will benefit too in the medium term.

At home, inflation came in at the low end of the Reserve Bank’s (RBA) target range and unemployment was stable at 6.2%. A few jobs were lost but the general trend for jobs has been solid. These monthly numbers do bounce around quite a lot so it is the trend that is important.

The big take-away from recent data releases and comments is that the pessimism surrounding global growth has subsided but nobody believes the US Fed anymore that they will lift rates in 2015. March or June 2016 is being pencilled in by markets.

But will we cut rates at home? The consensus view is that there will be one or two more cuts but it is so hard to say when they will occur. But with our big banks raising home loan rates without any move from the RBA, a cut sooner rather than later is more likely.

Asset Classes

Australian Equities

There were a few spectacular adverse reactions to company reports and guidance. Woolworths and Dick Smith were hit particularly hard, and the two big banks with significant overseas exposure, ANZ and NAB, did not fare well on their announcements.

Woolworths has been a market darling for a very long time and its cosy position with Coles made market strength a given. But, with new market entrants establishing a presence in Australia investors might be wise to rethink their views of any company likely to face new challenges.

Our market gained +4.3% in October but the last week saw five down-days on the run. We have our market still quite under-priced at -5.5% below fair value. Growth prospects are still strong but we still have to emerge from the recent spells of volatility before a solid up-trend emerges. Santa might bring one!

Foreign Equities

The Q3 US company reporting season produced an unusually large disparity between hits and misses on expectations. This disparity caused some market volatility but the US ‘fear index’, known as the VIX, has been trading at levels well below its average.

The US, S&P 500, had a bumper October gaining +8.3% and the German DAX gained +12.3%. The London FTSE was up +4.9% and the World was up +7.9%. We didn’t even keep up with Emerging Markets that gained +5.4%.

But we don’t see our +4.3% gain in October as a problem. Because our market is closed when Europe and the US is open, and vice versa there is often some nervousness on our part about going too hard on the back of foreign leads – just in case the trend reverses overnight.

Bonds and Interest Rates

After the US Fed kept rates on hold at the October meeting, the market’s odds for a March hike went up to over 60%. The Fed is still talking about raising rates this year but the market has become accustomed to the current situation so no immediate change is now needed.

The Reserve Bank of Australia (RBA) also kept rates on hold again in October and there is an increased chance of a Melbourne Cup cut after the big banks’ home loan rate increases.

Other Assets

Iron ore prices slipped below $50 a tonne from over $55 during October. There was some bounce back in oil prices and our dollar was volatile.

Regional Analysis

Australian employment slipped in September by  5,100 but this read is well within statistical sampling variation of recent stronger results. Inflation came in at around expectations and within the RBAs comfort zone.

But the big change in our economy was the ‘out of cycle’ rate rise by each of the big four banks. The reason for these hikes is simple. Although our banks got through the GFC much better than those in the US, UK and Europe, our regulators have been forcing the big banks to hold an even bigger cushion of cash – particularly, in case if there is any adverse movement in our property prices.

Since cash on a bank’s balance sheet earns a much lower return than a comparable amount lent out for home loans, banks’ profitability would have fallen without some action on their part – so banks lifted home loan rates to restore their levels of profitability. And that means the RBA can now lower rates for general lending without home loan rates falling below recent previous levels. The RBA has to be prudent in the impact of its policies on property prices and any possible overvaluations.

China

China’s imports and exports data in October showed falls but imports fell in line with expectations and exports were almost flat rather than nose-diving as markets had been expecting.

Retail sales data also continued to be strong. And economic growth came in at +6.9% which is just below the +7% target. Officials have again come out supporting continued strong growth but it will be more skewed towards the consumer rather than government spending on infrastructure.

The Purchasing Managers Index (PMI) came in at 49.8 – unchanged from last month. Above 50 is better but 49.8 is just fine.

The China leadership is currently formulating its next five-year plan. But already they have abandoned the one child policy in favour of two. That in itself will boost growth in the medium term.

U.S.A.

The US unemployment rate remained at 5.1% but there were fewer jobs created than anticipated. While the average job creation over the last two years has been around 230,000 – 240,000 a month, the last two numbers came in at 136,000 and 142,000.

But the Fed has improved its view of its economy going forward. It is now saying growth is solid rather than the modest tag it was previously using.
The US is facing a recurrence of the end-of-the-year debt ceiling negotiations to pay for things the government has already committed to!

Europe

With the UK still trying to renegotiate its position within the EU, Standard and Poor’s has announced that it will downgrade UK debt by one notch – or two notches if it leaves the EU and relations with Brussels then deteriorate.

A lot of the issue is how the UK can deal with population movements – particularly from the recent surge in illegal migration. The UK’s generous government benefits schemes are enticing migration to Britain, and that could destroy the system for all. So how can Britain look after its own? Leaving the EU is a strong possibility.

There are three central banks in Europe that now have negative deposit rates!

Rest of the World 

The Reserve Bank of New Zealand kept its rate on hold but there are concerns about dairy exports that underpin the New Zealand economy.

Japan is considering more quantitative easing to boost growth but pulled out of that commitment at the end of October.

There are now apparently 60 million people marching to Europe for safety and a better life. That’s three times the population of Syria and about the same as the United Kingdom. As we wrote months ago, it is not feasible to just try and assimilate them as first suggested by some. And there would be at least another 60 million behind if the first sixty are accommodated.

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

** Australian Bureau of Statistics

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.

The Big Picture

August was terrible for stock markets around the world. While September may not have felt great, markets were volatile but mainly moving sideways – at least until the last few days of the month.

By far the biggest news from last month was the United States (US) Federal Reserve indecision on interest rates. This central bank flagged late in 2014 that its first rate hike in eight years from the emergency low setting of 0.0% – 0.25% would be “data dependent” but most analysts pencilled in mid-2015 for the event.

June came and went and September seemed to be the new date in economists’ minds – but not in market pricing by the people, who trade rather than talk. Although jobs creation has been quite strong in the US for a couple of years and inflation has been subdued, there was no need for a hike. But it is now seen to be embarrassing for the US to have rates so low for so long.

In the end, the Fed didn’t hike last month but it was the accompanying statement released at the press conference that spooked markets. In essence, the Fed argued that global growth looked like a bit of a problem and recent volatility made it a good idea to wait. It was that latent Fed fear that put markets into a spin.

Dr Yellen, the chair of the Fed, gave what would normally have been a low-key speech a week after the press conference at a university but everyone was waiting and listening for a signal. Yellen’s voice uncharacteristically faltered during her speech and she wasn’t able to finish the speech or answer questions as planned – and she needed medical attention when she left the podium.

The official statement said that she was suffering from ‘dehydration’ which seems a bit like a ‘drunk’ politician on TV claiming to have been ‘tired and emotional’. The stress for Yellen must have been immense in her bid to quell market uncertainty. We certainly empathise with her. She said what we wanted to here – rates will likely go up this year.

Most of the Fed members have now joined forces to say that rates will go up this year but there are only two meetings to go in 2015 and one of those has no scheduled press conference to follow. A quarter of a per cent rise (or less!) would have no impact on the real economy and inflation is too low to worry about. It is a case of getting a rate hike out of the way so we can all move forward.

But just “carrying on” isn’t what is happening in Australia. Malcolm Turnbull swept into the Prime Ministership and had an immediate big positive impact on consumers. The first consumer confidence index report after the spill came in at +8.7% which is the biggest improvement since the index was created about seven years ago. Unsurprisingly, the index did pull back a little in the following week.

Jobs data at home were again strong. Rates were also kept on hold but a cut soon is quite possible. A hike is out of the question.

So we are all waiting for the Fed to pull the trigger to set our minds at rest. Until then, it is quite likely that market volatility will continue. However, the long-run prospects for us look just as strong as they were a few months ago. It is just so hard waiting!

Asset Classes

Australian Equities

The market moves in the last few days of the month were crazy. No human knows why the daily changes were so large.

Even though only two days in September saw the ASX 200 finish below 5,000, the sinking feeling pervaded most investors’ thinking. The market lost  3.6% on the month. We have estimated that the market has a fair value of 5,700 so the market was very cheap by our reckoning at the end of September by  12.0%.

The current volatility is unlikely to be a long-run problem – or so we think – it is the price for staying in the market. In a month or two the volatility could well subside and we can be headed on a ‘normal’ path upwards. If Turnbull injects that innate quality Australians have to win into our political decision-making – everything could change for the better sooner rather than later.

Foreign Equities

No market was spared from the down draught that hit markets in September. Markets go up and down. Confusion creates volatility but we see the long-run future as solid.

The S&P 500 was down ???2.6% on the month; the German DAX was down ???5.8%; and the London FTSE was down ???3.0%.

Energy, Materials and Healthcare were the sectors worst hit around the globe.

Bonds and Interest Rates

We thought – and still think – that the US Fed does not need to hike rates for the first time this year to control the economy. But it made such a mess of its communications after the September meeting that it needs to act quickly – so that it can signal that it believes the economy can sustain a little hike – even if it doesn’t need one!

The Reserve Bank of Australia (RBA) also kept rates on hold again in September. It would probably be wise for the RBA to wait and see what impact, if any, the new Prime Minister and Treasurer will have on business and consumer confidence. A rate cut is still possible this year, but it is now much less likely than it seemed last month.

The New Zealand Reserve Bank cuts its interest rate for the third time this year.

Other Assets

Iron ore prices have stabilised at just under $60 / tonne. The Brent oil – world – price is also stable but the US oil price (WTI) did fall a little over September.

Australian employment improved yet again – by +17,400 new jobs in August. Unemployment came in at 6.2%, which is down from 6.3% the month before. GDP growth for the economy was weak at +0.2% for the quarter ending in June but +2.0% for the year.

The main problem we have been facing in growing our economy is getting business to start investing. Lower rates alone are not enough to induce confidence – it is the political backdrop that shapes business conditions.

Turnbull has started off as an assured leader who will not be badgered by questions from the media trying to force him to make policy decisions on the run. While nothing is certain in this world, we now have a good chance to get things going again.

In his ‘previous life’ Turnbull was a journalist, a highly successful barrister and an investment banker. Possibly more than most in parliament he has the experience to communicate with big and small business. And since he seemingly uses public transport whenever reasonable in his work he might well shake off the arrogant tag he had when he was previously the Coalition leader.

China

The China Shanghai Composite stock market index has seemingly settled down after a  30%+ fall from its peak in the middle of the year.

Retail Sales and Industrial Output are still growing at double-digit rates but Industrial Profits did fall significantly last week. The problem in China is similar to the one that is affecting most countries in the world. Oil (and other commodities) prices have fallen significantly over the last year or two and that impacts on measuring inflation and balancing costs and revenues for profits.

China’s General Secretary Xi Jinping visited President Obama in the US to strengthen its role in the world. China is transitioning its economy into one that is no longer just dependent on infrastructure spending and exports. It needs to get its currency accepted as being traded in a mature market. It is a long road but China – like all major countries before – will do all that it can to perform well. It is capable of more stimulus to maintain strong growth if needed and probably will do so.

The 1st of October official measure of manufacturing output exceeded expectations and last month’s number, it was only just shy of the ‘sweet spot’. That’s why markets rallied hard on the news and again the ‘perma-China-bears’ ducked for cover.

U.S.A.

US economic growth was revised upwards for the second and final time for Q2 to +3.9% over the year. The nonfarm payrolls (jobs increase) were a little on the low side at +173,000 but one number does not make a trend. And these numbers also often get revised.

The US unemployment rate now stands at 5.1% but the problem is that, as manufacturing languishes in the US, people are moving into the services industries for work. The average rates of pay in many services’ roles are less than those in manufacturing so wage growth is not accompanying jobs growth – a bit like here in Australia.

Europe

European news is still dominated by how the European Union (EU) can deal with the immigration/refugee issue. Putin is now involved in Syria, but no one is quite sure which targets his air force is bombing! This ISIL problem is exceptionally difficult to solve.

The Greek Prime Minister, Alexis Tsipras, was re-elected in his snap election by forming a coalition with a small number of right-leaning independents. This solution means that it is more likely that Greece will co-operate with the rest of Europe to control Greece’s debt problems.

In due course – if it bites the bullet – debt forgiveness will probably follow so that Greece can rebuild its future.

In spite of strength of its economy, the United Kingdom (UK) has seemingly postponed the mooted rate hike until next year. Jeremy Corbyn was elected leader of the (opposition) Labour party that was decimated when the Scottish National Party took all but one seat from Labour in in this year’s general Scottish election. Since Corbyn is from the extreme left, it looks like Labour will be in the wilderness for many years to come. Tony Blair was arguably such a successful Labour leader because he – like Hawke and Keating – took a far more ‘centrist’ approach.

Rest of the World 

Japan has been struggling for a couple of so-called ‘lost’ decades in a low-inflation environment. Prime Minister Abe brought in three new policies this September in a hope to turn the latest negative inflation read around. But Abe’s main problem is stemming the predicted fall in population. He is claiming he will be able to stop the current population of 127 million from falling below 100 million in the foreseeable future! That is, natural attrition will remove more than the population of Australia from the Japan total in short order!

Iran is getting ready to get its oil exporting up to normal levels after its successful negotiations over its nuclear presence – possibly producing as much as a billion barrels per day. Since oil prices are already depressed, this extra supply is likely to keep a cap on oil prices in the medium term. That’s very good for consumers but not so good for producers.

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

** Australian Bureau of Statistics

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.

The Big Picture

After a great July in markets, many stomachs understandably churned as fingers were pointed at China’s stock market during August.

We listened to and watched well-dressed people with sincere faces likening the China stock market falls to the Lehman Brothers collapse in 2008. Nothing could be further from the truth. Lehman’s was a massive investment bank and the main problem was that no one knew who held the complex web of Lehman’s massive debt – so credit markets locked up.

China is transitioning from a poorly run Communist country to a world powerhouse – while remaining Communist. That is a difficult task, but China has been doing tremendously well. The China authorities know that every good capitalist country has a well-functioning stock market to allow for secondary trading in companies.

The so-called Shanghai Composite Index is a measure of a China market in its infancy. Unlike, say, Australia, there is very little institutional investing there. In Australia, we have the likes of BT, Colonial First State and many, many other sophisticated investment houses researching and trading in the relevant companies. We even have a substantial overseas investment in our market.

The Composite is dominated by mum and dad investors. The vast majority of mums and dads do not invest in the market and those that do mostly rely on property and gold for their main investments.

So a year or so ago, China encouraged more activity in the Composite and provided cheap loans for margin lending to promote involvement. The market rose more than 150% in less than a year so, even after the recent falls; the capital gain over the last 12 months has been mammoth! The point is, share market activity has little to do with economic activity in China.

So when global investors got caught up with the obvious overselling of mature markets, the China market continued to fall while mature markets surged from the bottom. Of course China did some good work in adjusting monetary policy that helped matters but – basically – our market was simply oversold.

A few other events disturbed thinking at the same time – the China dock explosions and deaths; the Bangkok bombings and deaths; ruminations in the US as to when the Fed will eventually hike rates; etc., etc.

It is often the case that when a lot of adverse news bombards markets, people sell first and ask questions later. Of course, these are the times when professional traders can make a killing.

While all of this was noise going on, the USA reported some spectacular growth data and reasonable labour market data. Our labour market data was also just fine.

So, in the next few weeks we expect markets to start to look far more settled and growing. And investors might even be looking for a Santa rally.

But one thing is bothering. There are almost constant news reports on the BBC of immigrants flooding into Europe from Africa and the Middle East. While some people are genuinely fleeing war and oppression, lots being interviewed just want a better economic life. While it would be great to accommodate all of these people in Europe, there are obviously even more people who will follow as ‘family’ and/or other illegal immigrants to the point where European standards of living would fall measurably. The problem must be solved – and soon.

Asset Classes

Australian Equities

Our market suffered a major downturn in August losing ???8.6% on the month. However, most other major international markets took a similar hit and our market started a recovery at the end of the month.

The Energy and Industrials sectors took much of the brunt of the fall on our market and no sector was spared. We have fair value for our market to be 5,750 making the end-of-August level of 5,207 quite underpriced.

Reporting season in August was not strong enough to dominate market movements but more than half of the companies that reported beat consensus estimates, which is about normal.

Foreign Equities

The VIX index is a measure of volatility, which many use as a ‘fear’ index for Wall Street, spiked a week before the end of the month but it too started to settle by the end of August.

Most major overseas markets are down on year-to-date, by around ???4% to ???5%. Since we have these markets also under-priced, we see most markets to be up by the end of the 2015 calendar year.

Bonds and Interest Rates

As September approached, more and more analysts were coming to the view that September is too early for the Fed to raise rates in the US. Fed member William Dudley has all but ruled out September. October is also less likely since there is no scheduled press conference to follow the Fed meeting.

We maintain our view that the first hike could be as late as 2016 as there is little to gain by going earlier. We also think it is quite likely that the first hike might be less than the traditional 0.25%.

China cut rates by 0.25% for the fifth time since November last year. It also cut the amount that banks have to hold against their lending.

The Reserve Bank of Australia (RBA) kept rates on hold in August and again on September 1. Perhaps the recent gyrations in markets might force its hand soon – one more cut is still possible this year.

Other Assets

Iron ore prices seem to have stabilised at moderate levels. Oil prices, that were plummeting, surged +10% in one day near the end of August. Oil prices rose a massive +27% in a three-day fight back. Russia and OPEC countries must be hurting, but oil importing countries are benefitting from lower prices.

The Aussie dollar continued to be volatile. It started the year well into the 80s but is now in the very low 70s.

Australian employment improved, albeit marginally, by +38,500 new jobs. Unemployment came in at 6.3% but, importantly, the official trend measure is still stable at 6.1%. The 6.3% number is most likely higher through statistical sampling errors.

The RBA left rates unchanged in August and at its 1st September meeting.

Various economic statistics continue to be mixed. It seems the political process is stuck in a rut and that is not helping the economy grow.

China

The China “perma-bears” had a field day when the Shanghai Composite index went into freefall again. But, as always, the authorities came to the rescue.

They devalued their currency, cut rates, reduced capital requirements for the banks, injected money into the system and deregulated pension holdings. Quite a lot for one month but that is why we are confident China will continue to manage its economy well.

On the real side of the China economy, the Purchasing Managers’ Index for Manufacturing slipped below the key 50 level to come in at a three-year low of 49.7. Of course, the latest rate cut has not yet had a chance to work but it is worth continuing to watch activity in the world’s second-largest economy.

China now has built an array of man-made islands in the South China Seas – complete with military installations. Clearly China not only wants to keep a hold over any oil and gas explorations in the region, but it also wants to have a strategic hold over shipping activity in the Singapore Straits.

U.S.A.

The Federal Reserve may be in a quandary as what to do about rate hikes, but there is in no doubt that the economy is booming. With Q2 growth at +3.7%, it looks like a no-brainer for the first hike soon but the Fed might not want to rock the boat with all of the market volatility that went on in August.

US jobs were a little soft this month – just +215,000 new jobs when recent averages have been more like 240,000. But unemployment is still steady at a low 5.3%.

We still think caution will prevail and a very small cut later this year or at the start of next will be the go. We doubt whether it will have much effect on us.

Europe

European news is dominated about how the European Union (EU) can deal with the immigration issue. People smugglers are taking so many would-be immigrants to places that just can’t cope with the influx. Sadly, tragedies abound as smugglers push the limits.

The Greek Prime Minister, Alexis Tsipras, called a snap election. A caretaker PM is now in place, but the election will be soon. Since one-third of his party did not vote with him in the bailout negotiations, the snap election is an attempt to rid his party of that element and leave a functioning parliament in its place. That will further stabilise the European economies.

In the UK, the race for the leadership of the Labour Party is taking on pantomime proportions. The claim by Labour is that non-Labour people have been signing up to vote for the leadership so that the outsiders can elect someone that has no chance of ever becoming Prime Minister! Given the rise in the Scottish National Party after last year’s referendum, it is possible the current structure means that Labour has little chance anyway in the near future.

Rest of the World 

Russia’s GDP came in at ???4.6% on the back of the slump in oil prices and the Ukraine-related sanctions. Other oil-exporting countries like Venezuela and Saudi Arabia are also feeling it.

Venezuela and Colombia are having their immigration difficulties too, but Venezuela is just shipping illegal immigrants back in droves.

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

** Australian Bureau of Statistics 

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.

Short-term volatility always makes investors nervous. Importantly, for advisers and your clients it’s about talking through with clients the reasons why they are invested and relating this back to their advice goals and objectives. It’s vital to remember that inevitably short-term volatility is experienced in markets, and the longer the timeframe to achieve clients’ goals and objectives the more likely market ‘ups and downs’ will be experienced.

The fact is…
Market Update: Dr Ron Bewley, Woodhall Investment Research

No one can deny that markets have sold off heavily in the last little while, but why?

Markets are driven by investors who do not know the true value of the constituent companies and use all of the signals they can find to adjust their views. September has been a big month on the calendar for the whole of 2015. That is when most analysts expected the US Federal Reserve to make their first interest rate hike since the GFC struck.

The US

Quantitative Easing – the programme of expanding the money supply – ended nearly a year ago in the US without any tears. The current official interest rate setting is a band from 0.00% – 0.25%. Traditionally the Fed moves like us in multiples of 0.25% changes in rates. However, the Fed recently flagged that it is prepared to move in smaller amounts in the first instance.

Rates in the US, here and most developed countries, are currently so low that even a 1% hike would still leave us all at lower than emergency settings – so why would anyone be worried about a hike of 0.25% or less? The answer is simple. It has nothing to do with the cost of borrowing. It is all to do with what we believe the Fed is thinking in terms of its confidence in its own economy. If it hikes, the Fed thinks the economy is strong enough to take it. If it doesn’t hike then the Fed will be perceived as being negative on the economy.

To complicate matters, The Fed moved too soon in the Great Depression and arguably prolonged it. So it has a bias towards not hiking too soon. Moreover, the costs to the economy of not hiking when it could against hiking too soon are so, so small. We have argued for some time that the Fed does not need to, and may not hike before 2016 but Fed watchers had pencilled in September.

Now that September is all but here, and the Fed is vacillating, analysts are getting spooked about the strength of the US economy. However, the all-important jobs data keep coming in comfortably above 200,000 new jobs per month and unemployment is at much lower than anyone expected a year or two go. True, wages growth has not been strong but that has been a worldwide problem.

When interest rates return to normal levels in say a few years, the stock market will not look quite as attractive relative to the yields on safer assets. Of course, markets often did well when rates used to be at normal levels but some investors always want to be the first out.

So in terms of long-run investing, we always maintained that rate hike would increase market volatility – and we have certainly seen high levels of volatility – but is it time to do something about it?

If the fundamentals remain strong as we expect, volatility will pass and markets will climb back up. Since there is no obvious sign that the fundamentals have weakened there is no point in selling. Indeed, such investors could be locking in losses. It is true that the US August reporting season was a little softer than expected but many companies beat expectations.

China

China is always a possible worry but its stock market – the Shanghai Composite Index – should not be. The recent sell-off is a little like the Reserve Bank of Australia (RBA) getting worried because there was a bad run on pokie machines in Australia. The Composite is dominated by mum and dad type investors and not institutions like ours and those in the USA. What is important is China’s ability to regulate and control the market. It did a good job in the middle of the year but in the round 2 sell-off they are being perceived as being less successful.

At the weekend, China announced that pension funds could now hold up to 30% in China equities – up from 0%. The fact that it had no impact on day one should not surprise. If you had never been able to buy shares and someone gives you the green light, how long does it take to work out what you want to buy and when? China also has an enormous amount of wiggle room in terms of cutting interest rates and reducing the Reserve Requirements Ratio for banks.

We would be very surprised if China cannot cope with smoothing out the ripples in its stock market. But what about its real economy?

When the ‘flash’ Purchasing Managers Index (PMI) came out last week, it shook some investors as, at 47.1 it was not just below the 50 level that separates improving growth from weakening, it was below expectations and at a six-year plus low. However, this flash read recently taken over from HSBC sponsorship is based on a much smaller sample than the official read and the flash read is only based on small companies. The flash read is often much less the official read which has been at 50 or above for quite some time. The next official read is due on September 1st.

Europe and the EU

Turning to Europe, except for migration issues from Africa and the Middle East, its economy looks stronger than in a long time. The India economy is starting to grow in a meaningful way and lower oil prices help economies that are net importers of oil.

In conclusion

To us, the recent behaviour looks like a ‘shaking-the-tree’ exercise where the weak run for cover and the seasoned investors buy up cheap. Of course this could change but for the foreseeable future this all looks like what has been an overdue correction in the US. We all caught the cold but after a few ‘sick days off we could so easily be back to growth quite quickly.

Yours faithfully,

Ron Bewley PhD, FASSA
Director
Woodhall Investment Research

^{Important information}

^{This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.}

The Big Picture

July was a bumper month for news that affected stock markets. The Greece debt crisis dominated the first half of the month. Greece started July by going into arrears on a $1.7bn loan to the IMF. But having the Finance Minister resign and immediately hop onto his motorbike wearing a leather jacket and a matt black helmet with a pretty blonde sans helmet on the pillion seemed to be the tops – but then the replacement Finance Minister (also a Marxist and former academic) was so relaxed he didn’t bother to take written comments to the big Brussels meeting as he was requested to do – the dog apparently ate his homework and he asked for an extension. He got more than what he bargained for.

As a result, Greece finished up with a far worse deal than they voted against in June. But for the rest of us the Greece issue has probably gone away for quite some time. As we always thought, there would be no long-run fall-out on us – and, as it turned out – there wasn’t that much short-term volatility either.

In an unrelated crisis, the mainland China stock exchange seemingly went into meltdown. Unlike our market that is dominated by big fund managers making big calls, the so-called Shanghai Composite Index is dominated by “mum and dad” investors that border on having a gambling mentality – people that the China government was encouraging to borrow to get into the market. When the index fell by around one third in a couple of weeks in June-July it seemed bad until one realised that the index had gone up by about 150% in the previous 12-months.

The China Government stepped in and rapidly brought back order into the market. The index gained over 10% in a few days – another problem solved, but some volatility remains in that market!

Because iron ore was apparently being used for collateral on the China market, its price also took a nose-dive from just under $60 / tonne to a 10-year low of $44.59 before finishing the month at over $55.

Iran has almost struck a deal with six major powers to maintain its nuclear power programme without the weapons part. If, or is that when, the US Congress ratifies the deal, trade sanctions should be lifted and more oil will flow into an already over-crowded market. Oil prices are unlikely to rise anytime soon.

But there was also lots of good news. The UK got its best result since 2001 on household disposable income growth – after taking inflation into account.

US employment data and economic growth data were good without being great and our employment data points to last October (2014) as having been the peak for our unemployment. Every month since has marked a slight decrease. And the Governor of the Reserve Bank recently joined the chorus that unemployment may have peaked.

Nevertheless, our official interest rate looks set to fall at least once more this year. The cost – measured in terms of risk – is so small for another cut compared to a no-change or rate-hike decision, it’s almost a win-win for us (unless you are on a pension in cash).

And our Reserve Bank Governor has come out and said perhaps we should accept that trend economic growth going forward will be lower than what we were once used to.

Whatever the pundits might be saying, we still see new record highs on Wall Street in the remainder of the year and the ASX 200 breaching 6,000 sometime soon. In the meantime, there is a more likely chance of some sideways movement until all of the jangled nerves have settled down and our August reporting season to the ASX has been digested.

Asset Classes

Regional Analysis

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

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.

The Big Picture

The NAB business confidence survey came in at the best since August 2014, and the previous month, the Westpac consumer confidence index was the best since February 2014. On top of that, the Household Savings ratio is at last coming down to more reasonable levels reinforcing the confidence story. Don’t worry – we are still saving well but not hoarding in fear as we were.

On top of that, the official trend unemployment rate series for Australia – the preferred official index – peaked at 6.17% in December 2014 and has gradually improved each month since – to sneak to just under 6.0% for May!

Our GDP growth came in at 0.9% for Q1, 2015 and the number of jobs created again easily beat forecasts. The Reserve Bank kept rates on hold and the government got the pensions bill through parliament with the support of the Greens – within hours of Labor stating it would oppose it. At last our economy is starting to get going again.

China cut its official interest rate for the fourth time since November 2014 and removed its import duty on luxury goods. The main measure of manufacturing activity – the Purchasing Manager Index (PMI) – remains above 50 which indicates a slight rate of expansion.

Japan threw in a big revision to Q1 GDP growth – up from 2.4% to 3.9% on an annual basis. The UK delivered growth in pay of 2.7% on the year and ???0.1% on inflation – so people’s wages are better off (before tax) by 2.8% on the year.

The US posted a big +1.2% increase for the month on Retail Sales but some other data were a bit mixed. The June date for the US Fed to hike rates for the first time since the GFC came and went with no action – that’s not what most expected last year.

Indeed Fed rate official forecasts for the end of 2016 and 2017 have fallen to 1.75% and 2.75%, respectively. In other words, when rates do start to rise they are expected to do so very slowly. Some commentators think the first hike will be in September – and some even expect two hikes this year. But as the Fed keeps reminding us, the data must be strong enough first. We maintain that we expect that the first hike is more likely to happen next year. But that’s not bad. Indeed, it would reflect prudent policy if the data turn out to be not strong enough.

Even Europe gets some plaudits. There was a release of some bumper PMIs for some European countries in late June. But of course there is Greece!

It is exhausting following the Greek crisis. They have a Finance Minister (who held a position in Marxist Economics in university) negotiating – or rather not negotiating – with the IMF and various European governments and policy centres.

Europe and Greece both want Greece to stay in Europe but the price of membership is that Greece must agree to get its house in order. Portugal, Ireland and Spain all started in a similar position in 2010 but those so-called ‘PIGS’ countries took their medicine and successfully exited the bailout program last year.

Without being too harsh, the conditions needed to get the next bailout required Greece to accept the sort of conditions that most of us in the Developed World – such as Australia – live in. Don’t avoid your taxes; lift the retirement age up to 65; pay GST in the Greek islands as well as the mainland, etc. And their top marginal tax rate is well less than ours! I suspect that whatever happens will have almost no long-run impact on our economy and markets.

Asset Classes

Australian Equities

The ASX 200 had a shocking month (down ???5.5%) and no sector was spared. Of course the sell-off at the end of June over the Greek situation exacerbated the situation but May and June together have taken us down from nearly 6,000 momentarily to under 5,400 – a 10% correction!

We see this dip as short-term volatility. The financial year starting today is likely to be really good. Our forecast for next June 30th is 6,200 – so that’s up 14% in 2015/16! On top of that we can expect about a 4.7% dividends plus franking credits.

The year 2014/15 that just finished was nearly flat at +1.2% but the returns including dividends were +5.7% which was a lot better than cash – and franking credits would take that return to about 7%.

And different sectors performed very differently over the financial year. Health was up +29.2% and Telecommunications was close by at +25.8% – both including dividends. At the other end of the spectrum, the Energy sector lost ???20.2% on the back of the falling oil prices.

Although we have the market very underpriced, high volatility might continue for a few months due to Greece and the US Fed deliberations.

Foreign Equities

Wall Street outperformed our market over June (???2.1% against our ???5.5%) but London’s FTSE (???6.6%) was even worse than the ASX 200.

While most markets have had big sell-offs in recent weeks, the S&P 500 is only ???3.2% off its all-time high.

Bonds

The bond markets are currently more volatile because of the Greek crisis and the talk from the US Fed about starting to make its first move in raising rates.

What is surprising is that the Fitch (a major rating agency like S&P or Moody’s) estimated one-year probability of default is only 1.02% for Western Europe. It started 2015 at 1.43% and reached as high as 4% during the GFC. Markets aren’t really that worried about Greece.

Interest Rates

Neither the Fed nor the Reserve Bank made any move on rates in June.  The Fed stressed that when it starts raising rates, it will be at a snail’s pace. Of course increasing the rate from 0% to 0.25% should have no impact on doing business but markets like to react to things that move – particularly when they are just coming out of hibernation!

There is no real consensus about whether we will get any more cuts at home this year, but any hike is a very long way off. There is a reasonable chance of another cut in a few months but it isn’t anything to bank on. A lot will depend on unemployment and inflation data over coming months.

Consumer and business confidence indexes are starting to look very good. Perhaps a rate cut would boost confidence even further. But nobody should be investing in a new business that critically depends upon one more cut. On the other hand, it will be interesting to see what the impact of the small business package from the May budget is.

Other Assets

Iron ore prices moved largely sideways in June but dipped below $60 / tonne for the first time in five weeks today.

Brent oil prices were relatively unchanged over the month, but they did dip a little at one point.

Perhaps surprisingly, the price of gold has been stable in the face the Greek crisis. It was actually down ???$US11 on the month.

Regional Analysis

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in today at 50.2 for the second month in a row. A number above 50 signals growing economic growth.

Like Greece, the China story will not go away for a very long time. The media feeds on stories and if there is no big news around it needs to find some. India is currently growing a little faster than China’s 7% target. And with ‘small’ China cities having more than 10 million citizens, there has to be a story to be found.

The PBOC (People’s Bank of China) just cut its main interest rate by 0.25% and its reserve ratio (the amount banks hold against loans) by 0.5%. China also removed import taxes from luxury goods. China is managing its economic destiny very well indeed.

Any prudent government changes tax rules and interest rates to glide an economy to where it needs. Think of Australia and what we are discussing about budgets and rates at the moment. China is no different. They are not panicking with massive or even big tweaks to policy. These changes would also look normal in Australia in recent times.

Yes, the first big wave of investment in China has ended, but much of China is still rural and poor. There will be more bursts of investment cycles to follow – after China has digested the impact of this last wave.

U.S.A.

After a very poor jobs number for March (+85,000 new jobs) the April data were quite strong with +223,000 jobs created and a 5.4% unemployment rate. The May number released at the start of June came in at a bumper +280,000 but unemployment slipped one tick to 5.5%. Only 225,000 new jobs were expected.

But the Fed is not happy with these numbers. The new jobs are still predominantly lower paying ones. Such employees typically spend all of their income on basics. They need wages growth to spread the gains across the economy.

The ???0.7% Q1 GDP growth figure (due to bad weather) was revised up to ???0.2% (both annualised) but everyone expected that. The US is sadly lacking productivity gains like so many other countries.

Europe

Europe ex-Greece is starting to do well – and in some places very well. Think back to 2010 when it looked like the eurozone might break up! That problem has gone away. Think of the start of 2014 when some talked of a recession in Germany. That problem too has gone.

Many mid-month preliminary PMIs were strong across Europe. Even Spain – with its 20%+ unemployment posted a number in the mid-fifties. Unemployment typically lags behind business expectations.

The Europe statistics are starting to look pretty damn good – even if you don’t include the UK. The UK growth in the first quarter of 2015 was just revised up to 2.9% over the year. Real (adjusted for inflation) household income was up a massive +4.9% in the quarter, and interest rates increase’s there are starting to be talked about.

Since midnight on June 30 has passed and Greece did not make its payment to the IMF, the bailout programme has officially ended. The referendum on Sunday is apparently worded as requesting a vote on continuing the bailout package – which no longer exists. Do they have the time to print new ballot papers and ship them out to the islands?

Sadly there is now talk of humanitarian aid being needed for Greece. Drug companies are owed more than a billion dollar’s but they have said they will continue to send drugs to Greece for now.

Rest of World Europe

Just when we thought Greece was enough of a handful, Puerto Rico announced at the end of June it had no chance of repaying its $72 billion debt. No doubt the US – with its very close ties – will bail them out. After all, you wouldn’t notice an extra $72 billion added to the $4.5 trillion US government debt!

The Iran nuclear talks are important. Depending on how they go, oil prices could move strongly either way on supply issues. Flip a coin.

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

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.