The Big Picture

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

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

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

Foreign Equities

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

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

Bonds and Interest Rates

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

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

Other Assets

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

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

Regional Analysis

Australia

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

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

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

China

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

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

U.S.A

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

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

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

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

Europe

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

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

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

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

Rest of the World

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

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

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

Important information

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

Foreign Equities

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

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

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

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

Bonds and Interest Rates

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

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

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

Other Assets

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

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

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

Regional Analysis

Australia

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

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

China

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

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

U.S.A.

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

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

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

Europe

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

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

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

Rest of the World

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

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

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

Foreign Equities

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

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

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

Bonds and Interest Rates

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

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

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

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

Other Assets

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

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

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

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

Regional Analysis

Australia

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

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

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

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

China

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

U.S.A

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

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

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

Europe

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

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

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

Rest of the World

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

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

Important information

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

The Big Picture

Most share markets were very strong in October so it was no big surprise to see markets take a breather in November. This was particularly the case as the big trigger for the next major economic trend is due in mid-December (16th) – the US Fed’s decision on its first rate hike in seven years.

Jobs data in the US were a bit weak as released in September and October. In contrast, November’s release was very, very strong. Markets expected a below recent average 185,000 new jobs but the data revealed a rather large 271,000 jobs! Unemployment was steady at 5.0% and there, at last, was some moderate wage growth at 2.5%. It would now take a lot on the 4th December in the next jobs’ release for the Fed not to hike at its next meeting.

On top of jobs, the US economic growth in Q3, measured by GDP, was revised up from +1.7% to +2.1%, and the market has priced in more than a 70% chance of a rate hike. Since a hike means the Fed’s rate will still only be in the range 0.25% to 0.50% there can be no material effect on the real economy. Markets could react but it has been so well telegraphed – and tested a few times before – that volatility should be reasonably well contained – unless, of course, the Fed does not hike! That would be big, bad and ugly for markets.

No matter on which side of politics you belong, Turnbull has turned around the fate of the current government immeasurably. The Westpac – Melbourne Institute Consumer Sentiment Index is up a massive +8.1% in the two months since the leadership spill.

The level of economic argument is now clear and inclusive of all Australians. It will take a while for our economy to return to higher levels of growth but it seems the process has, at last, begun.

Our jobs data surprised many as unemployment fell to below 6% and +58,600 new jobs were created. As we often report here, much of the month-to-month variation is due to statistical sampling error. There is almost no way these numbers can have a bad spin but a return to trend unemployment of 6.1% in December is quite likely.

The Reserve Bank of Australia (RBA) although not cutting rates on the 1 December stated that the next change will be down if any change is made soon. However, the current consensus view of economists is that the next change will be up – but not for 12 months of so.  These views are consistent.

As the China economy rebalances from mining to consumer-driven activity, Retail Sales data is becoming more important than manufacturing data. The sales data is strong and the latest government statement is for economic growth to be around 6.5% for the next five years – only just below the current 7% target.

The biggest issue in China is the South China Seas confrontation. China has built some man-made islands and is claiming new stretches of international waters, and the US is flexing its muscles with its navy patrolling in the area.

Russia and Turkey are also in confrontation – about Syria. Interestingly, sanctions against Russia are not being talked about – as they were with the Ukraine issue.

The migration issue is still growing in its magnitude and now the European Union is offering Turkey money in exchange for Turkey holding onto the refugees crossing the border from Syria into Turkey.

By Christmas, so much economic uncertainty will have evaporated, and 2016 is much more likely to be better than the current year.

Asset Classes

Australian Equities

The ASX 200 was down ???1.4% in November but volatility and ‘fear’ are subsiding. The Materials sector was down ???12.6% in the month and the Healthcare sector was up strongly by +5.3%.

We have seen no evidence that the fundamentals have changed so our long-run view of our market is fine. We just suffered recently from panic selling around the US Fed’s comments.

Foreign Equities

The German DAX was up strongly in November (+4.1%) but other major indexes were relatively flat.

The China Shanghai Composite stock market index had a really bad day (-5.5%) near the end of the month but the next day was flat.

The US and Australian fear indexes are both at below average levels.

Bonds and Interest Rates

The RBA has kept rates on hold at 2.0%. The next meeting is in February but most are expecting rates to be on hold for the best part of a year – and then up.

Everyone is waiting for the statement following the December 15 and 16 meeting of the Federal Reserve. Almost everyone is saying that the first hike since 2008 is virtually a given for December.

The Bank of England was positioning itself for a rate hike earlier this year but now they are saying that there is no rush.

Other Assets

Iron ore prices continued to languish. But BHP’s share price falls are as much to do with the Brazil dam disaster as ore prices. Oil prices did rebound somewhat at the end of the month, but were still down sharply over the month. OPEC is due to meet to consider reducing supply to support prices, and Gold prices hit a five-year low in November.

The jobs data showed that +40,000 full-time jobs were created in October as well as +18,600 part-time jobs. Unemployment fell from 6.2% to 5.9% over the month. However, the official trend unemployment rate has been steady at 6.1% for months.

The proper interpretation is that unemployment is stable at a reasonable rate, and employment growth has been averaging a solid +20,000 new jobs per month over the last year. The economy is stuck in reasonable but not good territory. If the spell of consumer confidence grows further the economy could soon return to full employment.

While the Westpac confidence index has shot up by +8.1% in two months, it is still only just above the 100 level that separates optimism from pessimism.

Access Economics – Deloittes – a very well regarded group of analysts – is now saying that at current settings, the budget deficit will never close! Indeed forecast deficits are starting to blow out and action must be taken.

The Hockey budget of two years ago was on the right track but the government failed to sell the policy initiatives, and Morrison appears to be taking stakeholders with him. The budget situation is certainly not yet dire but it will become so if solutions are not passed through parliament.

China

China’s Purchasing Managers Index (PMI) for Manufacturing started October at 49.8 – the same as in the previous month – which beat expectations. Today, it came in at 49.6 which was slightly below expectations. So manufacturing is more or less holding its current growth levels.

Retail sales stood at +10.9%, so the consumer side of the economy is working very well. As consumerism grows, the relative performance of Retail Sales will grow.

The ‘fifth plenum’ – or meeting of the major government players emerged with a strong statement for future growth. They are targeting +6.5% pa or the next five years.

U.S.A.

In the first month following each quarter, the government releases a preliminary estimate of economic growth and then revises it in each of the next two months. It is often the case that the first number is revised upwards. This month was no exception. The moderate +1.5% (annual) estimate for the September quarter was revised upwards to a quite reasonable +2.1%.

All in all, the US economy is fine but the Fed needs to confirm that view with a rate rise at its December meeting. More hikes will follow but at a much slower rate than is usual.

Europe

The European Central Bank (ECB) is positioning itself to bring in more stimulus and the markets like that. The German economy is doing quite well and the debt disruptions are becoming a thing of the past.

Migration issues are, of course, worsening but the terror attacks in Paris – and thwarted attacks elsewhere in Europe – seem to have focused attention on finding a solution that does not simply mean free movement across the borders.

Rest of the World 

Japan’s economy continues to disappoint. It just shows how hard it is for an economy to get out of a deflationary spiral which is why everyone else is pumping money into their economies to avoid deflation.

Russia is involved in Syria but more in propping up the government rather than fighting IS. The shooting down of a Russian jet fighter has obviously heightened tensions in that part of the world. Although there are reports that Putin is ready to mobilise troops, the matter seems to have been contained – so far. The US and Russia need to join forces to solve the IS problem.

*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 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.