Economic Update

Economic Update – May 2020

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

The recovery begins?

– Equities bounce back strongly in April as unprecedented fiscal and monetary stimulus applied
– Economies in early stages of starting to re-open as the COVID-19 rates of infection have slowed
– Oil prices face turbulent times and demand falls dramatically absorbing OPEC production cuts

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

After a really tough month for stock markets in March, the bounce back in April gave investors a chance to catch their breath. Of course, it is possible a new low will be formed at some time in the future but the news on COVID-19 is starting to get better.

It was quite rational for markets to have fallen as sharply as they did in March. After all, no one knew the extent of the devastation that the virus would cause. As soon as governments and central banks responded with stimuli, lock-downs and social distancing, markets realised that they had sold off too much.

We think the major markets are still cheap based on reported earnings but volatility and fear are elevated. As a result, the rate of price appreciation going forward over the longer term versus what we think of as fair pricing might be slower than what we experienced in April.

There have been so many stimulus packages and healthcare innovations, it is an impossible task to report all. And new changes are coming through with such speed that any attempted comprehensive report would rapidly be out of date. In the space of a month, global sentiment seems to have gone from doom and gloom in markets to ‘it’s not that bad’ after all.

We think the important take-away is that almost all major countries are rapidly responding to the challenges – unlike in the wake of the GFC in 2008 and 2009. Health authorities and scientists are seemingly working tirelessly to develop vaccines and provide cures. We think we are in safe hands! But Trump did take issue with the World Health Organisation (WHO) over their early responses (or lack thereof) to the onset of the crisis.

There are questions about whether or not people who have experienced a COVID-19 illness can be re-infected. As finance experts, we have nothing to offer on that question but we do take this uncertainty into account.

Many countries have already started to relax the lock-down restrictions – mostly in a phased fashion. It makes sense to respond in this fashion as it would be imprudent to run economies into the ground to ensure, like smallpox, the disease has been eradicated. That means that there will be future waves of infection in much the same way that there are usually weaker aftershocks following an earthquake. Because different regions are loosening restrictions in different ways there is a chance to learn from one another.

All economic data will likely be really bad for many weeks and possibly months – so there is no point in dwelling on them. If we look for a medical analogy, economies are experiencing ‘self-induced comas’ to allow doctors to deal with the patients’ needs in a timely fashion – rather than dealing with a recession-like trauma rapid-fire scenario in the ER.

Another point worth noting for less experienced readers is the bias that most forecasters put into some of their forecasts. It is well known that forecasters often indulge in so-called ‘rational cheating’ to use an academic term. It is often not in the best interests of the forecaster to publish their ‘honest’ best forecast but rather modify it in the light of the consequences of being wrong.

In the current situation, a forecaster who believes economies will be back to normal in short order would be well-advised not to say so. If the economy actually takes a longer time to recover, the optimistic forecaster is likely to be the object of much scorn. If the optimist is right, there are no particular prizes to win. On the other hand, a forecaster who overstates the time for recovery (at least by a little) will lose nothing if, indeed, it takes a long time. If a quick recovery happens, everyone is so happy that they ignore that the forecaster was, in fact, wrong.

With this bias in mind, we suggest that the consensus view for recovery that is published might be biased towards the longer run. Recall all of the eminent economists (including Nobel Laureates) who said, following the GFC, that a depression longer than the Great Depression was likely. How wrong they were – but can you now name them?

The impact of COVID-19 was more than enough for analysts to try and work through during April but oil prices also went into a tail spin! The timing of the two phenomena might be related as it is thought Saudi Arabia has been waiting for the opportunity to run the relatively new US shale-oil producers out of business. What better time is there to attempt such a price war than one in which people were already hurting?

There is always the incentive for independent oil producers to compete for market share – which is why OPEC was formed in 1973. Since Russia and the US are big oil producers that are not OPEC members, price control by OPEC is limited. In an attempt to become self-sufficient in oil, the US has turned to extracting oil from shale as well as oil wells. We ‘passed’ on such ‘fracking’ in Australia.

Shale oil is now such an important component of US production that its output had a depressing impact on global oil prices.

OPEC+ (i.e. including Russia and a few smaller independent players) agreed earlier in April to a material supply cut to start from May 1st. However, the massive lack of demand due to COVID-reduced travel on land, sea and air has made even that cut insufficient to stabilise markets.

The US has a massive underground oil storage facility in the centre of the country (Cushing, Oklahoma). It is nearly full so that there is nowhere for more US oil (known as WTI or West Texas Intermediate) to be stored. As a result, many players had to sell their forward contracts at negative prices to prevent being forced to take delivery! This is a phenomenon that is likely to recur monthly as each forward contract nears expiry (the next is due on May 19).

The global price of oil (known as Brent) has been more stable but it has still been impacted through interdependencies. The Saudis reportedly can withstand these price gyrations for many months if not longer. However, the newer shale-oil producers are less cost effective and the first bankruptcy proceedings have already started.

The oil price war is unlikely to have a major detrimental impact on the market in the longer term but these oil price spikes do seem to cause excess volatility in stock market indexes along the way.
With regard to COVID-19 and oil prices, we believe that the prudent investor who started the year with an appropriately diversified portfolio should probably stick with it. Even experienced fund managers find it difficult to pick the right time to buy and sell. And this suggestion brings us to the opportunity many people are now faced with in super funds as some are able to withdraw up to $20,000.

Super is a wonderful, tax-effective way to save and should be preserved if possible. For many people, $20,000 is a sizeable chunk of their savings. Assuming a balanced rate of return of 7% pa on investments with an inflation rate of 2.5% pa, a 30-year old person due to retire at 67 would be forgoing $244,472 at retirement (or $101,937 adjusted for inflation). Compound interest is a powerful force! Early exit can be massively expensive in the long run for the young.

Of course, some people might have no option but to withdraw the $20,000 or part thereof but it would be wise to look for alternative solutions first and, perhaps, not taking out the maximum amount even if alternatives are not available.

The withdrawal is reportedly more problematic with some industry super funds. The TV adverts often point to the superior returns of industry super funds over retail funds. In making such a comparison and in considering the maximum $20,000 withdrawal, it is important to take into account the reported fact that many industry funds are more heavily invested in ‘unlisted assets’ such as property and infrastructure that are not listed on the stock exchange – some funds reportedly have allocations of up to 40% in such unlisted assets.

The price of, say, CBA shares is priced by the second during the time the stock exchange is open and the stock is not in a trading halt. If any average investor sells all of their CBA stock the impact of the sale on the latest price is minimal. However, if the same investor tried to sell all of their stock in a company outside of the top 300, there could be a material price fall. This price fall in ‘illiquid’ stocks should be considered when considering a sale and it is why many investors should only consider the top 50 or top 100 stocks.

An unlisted asset, such as a large (unlisted) building has no transparent market price. Rather, a valuer infrequently makes a judgement as to what price could be realised. Unlisted assets appear to be less volatile because no one is valuing them often enough to detect the true pricing volatility!

Also, when an investor attempts to sell a part of an unlisted asset there is no ready market of buyers. At any point in time, one can view the ‘order queue’ of what potential buyers and sellers will trade a listed share on the ASX.

If one super fund, industry or otherwise, is heavily invested in one particular unlisted asset and a large number of members want to redeem capital, the potential sale of the unlisted asset could destabilise the value of the fund as the price ultimately realised may be less than the value of the asset reported by the super fund. Given that some industry funds are reportedly as much as 40% invested in unlisted assets, those funds might be forced to sell just their liquid assets instead making the resultant asset allocation even more skewed to the illiquid, unlisted side. We think it is important to take proper financial advice whenever possible concerning such withdrawals.

We hope to be able to paint a clearer picture next month as the dust on COVID-19 settles. The current company reports for quarter one in the US are giving little guidance to the future. Therefore, we must rely on our broader macro view of the longer term as we have presented in this section.

Asset Classes
Australian Equities

The ASX 200 posted a strong gain over April (+8.8%) but this should be considered in conjunction with the ‘bear market’ sized fall in March.

Financials did relatively poorly in April in part due to the NAB trading halt – when they announced a cut in dividends and a dilution of capital through a capital raising. ANZ announced that it will defer its dividend. The other big banks also took capital losses as investors anticipated similar behaviour elsewhere in the sector – as we foreshadowed might happen in last month’s newsletter.
In spite of the oil price war, both the energy and materials sectors – making the combined resources sector – performed very well.

Market volatility has fallen sharply since the March high but it is still nearly double what we might expected in normal times.

Foreign Equities

The S&P 500 performed even better than the Australian market (+12.7%). Other major markets moved more in line with the ASX 200.

The VIX so-called fear gauge remains quite elevated but far below its record highs in March.

Bonds and Interest Rates

Several central banks have committed to continue to support government and corporate bonds. The Bank of Japan (BoJ) went so far as to state that it has an unlimited target of what QE (quantitative easing) it is prepared to use.

The US Federal Reserve (Fed) is also being creative in trying to support bonds of all maturities. At its April meeting it reiterated its plan to keep rates low at least until the economy returns to full employment.

We still expect our rates to be lower for longer and for longer-dated bonds to have a higher yield than the short-dated.

Other Assets

The WTI futures contract price of oil for May delivery even went negative at one point during April but both WTI and Brent prices, while highly volatile, have recovered somewhat.
The Australian dollar has continued to be unusually volatile fluctuating in a range from US60.35c to US65.66c in April.

Iron ore prices have been relatively stable but copper prices rose by 6%.

Regional Review
Australia

The rate of new COVID-19 cases has slowed to a mere trickle in Australia. As a result, governments are starting to relax some of the lock-down restrictions. Since the rules vary by state, and they keep changing within states, there is seemingly much confusion about what is legal and/or wise.

Although new cases are few and far between, there are plenty of people with the virus to infect others as restrictions are relaxed. Undoubtedly there will be future (hopefully much smaller) waves of infection.

The March unemployment rate published in April surprised many as it fell from 5.3% to 5.1%. However, the data are gleaned from a survey conducted in the first two weeks of the month (March) – before the lock-down started.

China

The China economy is starting to gear up again but at a slower pace than many expected. One reason could be the lack of demand and logistics in other countries. For the second month in a row the Purchasing Managers Indexes (PMI) for both manufacturing and services were above 50 – the cut-off between expected expansion and contraction.

Both the US and Australia are in heated discussions with China over how it handled COVID-19 during the early stages.

The weekly initial jobless claims have ramped up sufficiently to make some predict the unemployment rate will exceed 16% at some point. Since many of these unemployed people will be receiving additional benefits, 16% does not mean the same at 16% at some other time. Moreover, there will be many more job vacancies than normal in a recession when restrictions are lifted.

Europe

The UK prime minister, Boris Johnson, was in intensive care with COVID but he is already back in the office. The UK is still aiming for completing the exit from Europe by the December 31st deadline.

Rest of the World

Kim Jung-un, the North Korea premier, has not been sighted for over two weeks and fears for his health abound. As they have an unusual hereditary premiership, and he has no son, the choice of a new leader is, indeed, problematic assuming such transition is required.

Economic Update – April 2020

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

The new economy

– COVID-19 causes markets to tumble
– Governments act swiftly with relief packages
– Central banks co-ordinate significant monetary policy stimulus

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

The world is very different from when we last filed this monthly update. What was then seemingly largely a Chinese health problem that was largely under control has blown out to a full-scale pandemic.

It is important for all investors to realise the broad manner in which viruses are transmitted if we are to understand how to invest during such a health crisis.

At one extreme, governments could have let the virus run free and contaminate most people with consequent poor health cases – and worse. At the other extreme, all people could have been quarantined – as they did in China – so that the spread would be controlled and slowed down.

South Korea took a different route with lots of success. They had testing ready by early February and monitored the movement of infected people using credit card activity, CCTV cameras, and mobile phone tracking. That really worked but most countries might struggle with such a ‘big brother’ approach.

Without a rigorous approach to quarantining, most people who are not immune might get the virus. But, by taking a partial approach to quarantining, the speed with which the virus spreads can be controlled.

The reason to slow down the spread is to help hospitals cope with the maximum number of cases needing treatment at any one time. All countries will have experienced an increase in the number of cases to be followed by a fall in this rate. The timing of these peaks depends on the health policy among other personal factors.

Slowing down the spread is the so-called ‘flattening the curve’ approach. Britain started off by allowing the virus to take its own course and then very much implemented a ‘flattening’ policy. The US, to some extent, upped its game after a slow start.

The biggest danger in the flattening policy is to lift restrictions too early that then allows a second round of contagion. As long as there are ‘carriers’ in the community, a new pandemic could always start – that is, until there is a vaccine or cure.

It is impossible for any group of people to accurately predict the length of this crisis because different regions are taking different approaches and, importantly, changing those approaches over time.

The health statistics are easily misread. It is a relatively simple task to count the number who pass away from the virus. There would be some misclassification – especially in countries with lesser quality testing facilities. It is also relatively simple to count the number of people who recover as a proportion of the number who were deemed to have been infected.

What is extremely difficult to assess is how many people have been or are infected. Apparently, many younger, very healthy people could be infected and not even realise it – often by thinking they have the regular flu. To date the testing facilities in Australia and the US has been confined to people who have recently travelled or been in contact with someone who tested positive (or possibly the at-risk groups).

Since mortality rates and rates of infection depend very much on this ‘wobbly’ estimate, we may see differences across regions that are more due to the ability to test rather than health characteristics.

A new testing machine – apparently about the size of a toaster – became available from the end of March in the US. It can draw a conclusion about having the virus or not in 5 to 13 minutes – as opposed to the current far more intrusive testing process that takes three days.

If this new machine (or other better procedures) can be rolled out quickly we can have mass testing and work out who has recovered and, therefore, less likely to be re-infected (the US and UK authorities have stated that there is minimal chance of re-infection but some cases of re-infection have been reported in some other countries). Also, knowing who is infected can better alert people to self-isolate.

The Australian health authorities have said that there is an early indication that our new cases may have peaked! Of course, that is only possible if the current policies are maintained or tightened. Australia is slightly better off than our Northern Hemisphere friends. Many flu-type viruses are less rampant in warmer weather.

All life is precious but it is worth noting that the Spanish flu crisis of 1918-20 is reported by Wikipedia to have infected one quarter of the world’s population and killed 17 – 50 million people (with some reports as high as 100 million). That the current numbers are so low by comparison might be attributable to the action taken by governments around the world. It’s not easy to conform to social distancing and self-isolation but the impact of not so doing could be massive!

So, with that layman’s overview of how the health crisis has evolved to this point – and how it might develop going forward – we can now address the economic and investment implications.
Quarantining and related restrictions mean that some industry segments must close down for an indefinite period. Some people can work from home and some might be paid (at least in part) even if they are not actively working. The rest must rely on savings and/or government relief packages.

The current situation is very different from a recession. It is a self-imposed shutdown for health reasons. Recessions happen for a number of reasons but they usually build up in intensity and take ages to get out of. Once the virus is under control, our economies can bounce back to strength.

Of course, some people and businesses might never recover. That is why the government should, and is, preparing for that eventuality.

That brings us to how much relief (it is not really stimulus because it is partial replacement funding) is enough. Our answer is that no one knows, so why pretend we can say the Australian government’s $17.6 bn plus $66 bn plus $130 bn is appropriate? Rather, the question should be, “Is it enough to get the ball rolling and will the governments produce more if and when needed?” We think the answer to both is a resounding yes.

Along the same lines, it is pointless trying to work out whether data such as that on unemployment, retail sales or GDP is good or bad in the coming months. Ignore them. But when the virus is over, we will get some bumper numbers as the economy returns to normal and catch up spending takes place.

The US economy was quite strong going into the crisis and our economy was strong enough. The latest (pre-crisis) Australian data releases were 5.1% for unemployment and 2.2% (annualised) for GDP. What’s more the RBA has also acted swiftly and strongly.

The main thing to us is that we help each other as a community. Let’s not leave anyone behind!

So, what of the markets? Wall Street achieved an all-time record as recently as February 19th and we followed suit the next day. Both markets then sank the quickest into bear-market territory since 1987 and bottomed (for the first time?) on March 23rd. Wall Street made one of its quickest ever recoveries – gaining 17% in three days. Then volatility then kicked in again.

It seems far too late in our opinion to start selling unless forced. It is equally too soon to dive back in. Depending on risk tolerance, it might be the time for the brave to start dipping their toes in the water. Again, the big lesson to be learnt from this crisis is that these things keep happening so it is always important to try and stay on top of keeping our portfolios in shape when times are good! It is always too late when markets have crashed!

We will start to know it’s over and safe to watch markets again when volatility indexes return to normal levels. All of the standard volatility measures were higher in March than they were in the GFC! In 2009, it wasn’t until the beginning of March that the market started to build in a base in stable fashion – and that’s when volatility returned to normal.

We argue this scenario because a volatile market shows heightened uncertainty and so all news – particularly negative news – can cause another run down.

When we think of the fundamental value of companies and market indexes, we usually try to take a long-run view of earnings and dividends. If that is the case, a quarter or two of bad earnings would not typically play a big part in long-run considerations – especially as we expect a big bounce back above normal levels when the virus ends.

We have not yet witnessed any downward adjustment hence our reluctance to increase exposure to equities now on the basis that they are cheaper. It is worth remembering that the price of a security is primarily driven by the expected level and certainty of its future cash flows. While the stimulus measures and containment strategies are clearly positive, we still do not know what the ultimate impact on corporate earnings will be and hence we have sufficient visibility on earnings to determine the value of the securities and therefore the market on which they trade.

Next month we expect to have a much clearer picture of the economic consequences of COVID-19. With 24×7 news and self-isolation, it is too easy to get caught up in what is going on. Moreover, comparing fund performance is fraught with problems today. With such a short-sharp sell-off in bonds and equities, funds with a large allocation to illiquid assets that might not have yet been re-priced could look overly good. Don’t be fooled!

Asset Classes
Australian Equities

The ASX 200 reached an all-time closing high of 7,163 on February 20th 2020 and then fell sharply into the end of the month. It fell even more sharply into March 23rd. After that weekend, Wall Street bounced strongly as the $2.2 tn relief bill worked its way through the US Congress. Although our market rose too, we lagged Wall Street and many other indexes in the recovery.

All sectors were hit hard in March but, unsurprisingly, the Staples sector, including the big supermarket chains, fared best of the losers!

One needs to be careful with the big banks at the moment. The relief measures and rate cuts may well supress earnings which may, in turn, force some banks to cut dividends. It’s too early to say but we will keep an eye on the situation.

Foreign Equities

The S&P 500 reached an all-time closing high of 3,386 on February 19th 2020. The index fell sharply into March 20th but then had a stellar three-day recovery (the best on record) of +17%. Some say it is the quickest entry and exit from a bear market ever. Either way, it was quick but volatility then returned.

Bonds and Interest Rates

Several central banks including the Reserve Bank of Australia (RBA), the US Federal Reserve (Fed), the Bank of England (BoE) and the ECB made out-of-cycle rate cuts on top of those at the normal meetings.

The new RBA rate is now 0.25% while that for the Bank of England is 0.1%. The Fed quotes a range which is now 0% to 0.25%. Since we do not expect these banks to try negative rates, it looks like the end of the easing cycle. The next rate hike looks a very long way away.

These central banks also announced action similar to Quantitative Easing (QE) to allow markets to function properly while uncertainty runs high. The Fed has even gone the extra mile in announcing it will purchase corporate bonds as well as (government) Treasuries.

The US 10-year T-note went on a roller coast ride in recent weeks. It fell below 0.40% and then broke through 1.00% to finish between the two extremes at around 0.7%.

What is more important than the actual rate is the so-called bid-ask spread in the secondary market. If that gap gets too wide markets will not function as well. So far it is just manageable. Central banks are supplying sufficient liquidity.

The yield curve from the 2-year to 10-year Treasury-notes is now quite steep after “inverting” in the middle of 2019. The current slope is far from what one expects before a recession but the play book is out of the window.

Earlier in the year we believed rates were going to be lower for longer – as did most other analysts. We now say even lower for even longer. As risky as they may seem now, many investors will need to consider equities to boost their portfolio yields.

Other Assets

The price of oil went into free-fall over March ( 50%+). Some of this fall would be due to decreased demand from China and elsewhere. But the big problem is the price war between Saudi Arabia and Russia over supply restrictions.

Current oil prices are unsustainable but no one seems to have a clue when the price war will end. Until it does end, the energy sector of most stock markets is in trouble.

The Australian dollar has been unusually volatile fluctuating in a range from above US65c at the start of March to below US56c and finishing the month of March just above US61c.

Regional Review
Australia

The Labour Market Survey for February reported in March showed a decrease in the unemployment rate from 5.3% to 5.1%. Jobs’ growth was strong at +26,700. The labour market was strong before the onset of COVID-19.

Economic growth came in at 2.2% (annualised) against an expected 1.9% for Q4. But the forward-looking Westpac consumer sentiment index hit a 5-year low at 91.9 (firmly below the 100 cut-off between pessimism and optimism).

The government has launched two relief packages ($17.6bn and $66bn) with a third worth $130 bn under construction. With strict controls on social distancing and (currently) a low level of COVID-19 cases compared the usual countries we are in a position to deal with the crisis better than many.

Naturally, some poor economic data will be released in the coming months but we fully expect the economy to recover when all is done. We believe the notion that we will be heading back to normal within six months to be plausible. However, such things as a deeper economic malaise and mutations of the virus and other microbiological complications would change things. Moreover, in relation to the virus itself break-throughs on testing could shorten the down time.

China

The coronavirus outbreak started in China but, already, there are reports that the China economy is starting to get moving again. The problem they now face is that the countries that they would normally be exporting to are not yet ready to take them!

The monthly Purchasing Managers’ Index (PMI) was released on the last day of March – just as the lock-down in Wuhan was being lifted.

The manufacturing PMI came in at 52.0 against an expectation of 45.0 and a previous month of 35.7. Since 50 is the cut-off between ‘expansion and contraction‘, this outcome was a major positive.

The services PMI came in even higher at 52.3 compared to the previous month’s 29.6. Another massive beat.

We are less surprised than the interpretation widely seen on TV. The PMI survey asks a question similar to ‘are things getting better or worse than now without stating what now is’ (with 50 being neutral) and not about the predicted level of growth. Since things were bad at the middle of the shutdown, this number only indicates things are getting better. This stage is the first in what we anticipate to be a recovery.

The US labour data remained very strong just before the COVID-19 outbreak. New jobs totalled 273,000 for the month which was well above the expected 175,000 and the two previous months’ data were revised sharply upwards. The unemployment rate was at the 50-year low of 3.5% and the wage growth was a healthy 3.0%.

The latest weekly initial jobless claims data came in at 3.28 million which is four times the previous high. This figure was the first of what we see as a sequence of numbers that are impossible to interpret.

Trump has signed off on a $2.2 tn relief package and the daily briefings on the virus continue to report problems being overcome. Of course, the toxic feud between the two political camps continues to fuel conflict from time to time.

At the start of the month, Joe Biden effectively became the Democratic nominee to take on Trump in November. Trump’s popularity is at an all-time high in his presidency. There was even a 60% approval rating of the manner in which he is handling the pandemic.

Europe

Italy was the epicentre of the outbreak in the Western world but New York has since taken that unenviable spot.

Germany has pledged a relief package equal to about 30% of its GDP – or about three times what the US and Australia have so far each committed. It seems everyone is trying hard to get through this period with minimal political bickering. Wonderful!

Rest of the World

The Tokyo Olympics has been pushed back to 2021 as have other major sporting events. These are enormously expensive events to stage but, hopefully, the infrastructure and the athletes will come though. The latest Japan data on retail sales and industrial output were pleasingly better than expectations. Next month cannot look so good.

Economic Update – March 2020

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

Coronavirus and US elections disturb markets

– The coronavirus dominates news and economic outlook. Currently causing disruption to communities, economies and markets.

– The Democratic Party primaries have yet not yet identified a clear contender to run against President Trump in the US Presidential election in November.

– US economic data indicates the economy remains healthy, caveat being the coronavirus.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.

The Big Picture

Only a couple of weeks after the US-China trade tensions settled down, coronavirus (COVID-19) spread across the globe from the city of Wuhan, capital of Hubei province in China.

While we are not experts in medical matters, we must still try and navigate the impact of this virus on economies and markets.

Despite China having seemingly acted swiftly in containing the virus, it has spread to many countries around the world. It has not (yet) been classified as a pandemic (a global epidemic) and various heads of health organisations have said that it is flu-like and would only have a mild impact on most people. However, as with regular flu, the very young and old can have serious reactions and have experienced higher mortality rates.

To put coronavirus in perspective, about 12,000 people died in the US from ‘regular’ flu in 2018 – the latest complete year of data. No vaccine yet exists to combat coronavirus and educated opinion seems to suggest a solution is at least several months away, maybe longer.

Some of the production lost in China might never be recovered but most expect the March 2020 quarter to be impacted with a lesser impact on the June 2020 quarter. For example, the International Monetary Fund (IMF) shaved only 0.1% off its global growth forecast for 2020 but cut China growth from 6.0% to 5.6% for this period.

Besides China, Italy, South Korea, Japan and Iran have been particularly affected and even major sporting and cultural events have been cancelled or conducted without spectators.

So far, the direct impact on Australia has been limited but provisional plans are in place to shut down schools and similar centres if necessary.

While it is always difficult to ascribe precise causes to changes in stock market indexes, it seems reasonable to assume much of the sell-off in late February was due to the spread of the virus. Indeed, the strong changes in the direction of markets within a trading session (so-called intra-daily volatility) seems to be associated with news or rumours occurring in our 24-hour news cycle world.

Had it not been for the coronavirus, the noise created in the US primaries (that Democrats use to choose their candidate for president) would still have created some significant market volatility. There is still a large number of candidates including two on the extreme left of the party: Bernie Sanders and Elizabeth Warren. The larger number of more moderate candidates is splitting their share of the vote helping to make Sanders look like a leading contender – at least until the moderates consolidate their champions.

Although in his late seventies, Sanders is particularly popular with young voters. He is proposing free college education; wiping out existing student debt; decriminalisation of marijuana possession; and even the expunging of previous marijuana criminal charges! On top of that he wants free medical care for all and the outlawing of private health insurance. Of course, he has offered no reasonable costing of his plan nor the means by which he will raise money to pay for it all!

Many of the Democratic candidates are unusual in their ages compared to those of all past presidents. Not only would leading contender, Buttigieg, be the youngest ever elected president, he almost would be younger than Kennedy was even after completing a four-year term! Nixon, at just under 78, was the oldest sitting president after his two 4-year terms ended. Sanders, Biden and Bloomberg would be older than that before they even started their presidencies.

It is popularly suggested that the sitting president (in this case, Trump) is in the box seat if the economy is strong. With the official consumer confidence index read being over 30% higher than before Trump was elected in 2016 and the unemployment rate bouncing around the all-time low since man first walked on the moon, the US economy looks strong enough to be a positive for Trump.

While we do not want to predict who will be elected US president in November, we do believe it will be someone who keeps the economy on track. There are safeguards in place in the US system.

We do not know when the coronavirus issues will dissipate, it has the potential to get worse but at this point we think markets may have recovered within a few months, we just don’t know. With US 10-year and 30-year bond yields falling to record lows, growth assets remain viable investments for the longer term notwithstanding they will be subject to shorter term volatility. We, and most other analysts, do not as yet expect a global, US or Australian recession during 2020 though at this point, negative growth for the March quarter is seen as a likely prospect.

Asset Classes

Australian Equities

The ASX 200 reached an all-time closing high of 7,163 on February 20th 2020 and then fell sharply into the end of the month. The index was down 8.2% over the month. As we argued in our introduction, we believe the sell-off was largely due to news and rumours about coronavirus and the US election.

At the time of the peak we had the Australian market as only moderately over-priced. It is now cheaper by our metrics but heightened volatility means that it might be prudent hold off on deploying additional capital to equities.

The February Australian company reporting season is all but over. It is hard to judge the full impact of reporting season owing to the heightened volatility. However, our analysis of broker-based forecasts of company dividends and earnings strongly suggests the market was in a stronger fundamental position at the end of February than it was at the beginning. Therefore, we believe the market may continue to improve once the coronavirus situation is resolved and we are in a better position to evaluate the impact of the coronavirus on corporate earnings.

Foreign Equities

The S&P 500 reached an all-time closing high of 3,386 on February 19th 2020. At that time, we had assessed the US market to be significantly over-priced and in danger of a correction from any catalyst or otherwise be in for a prolonged sideways movement. The market sold off sharply into the end of February. It was down 8.4% on the month. Unlike with the ASX 200, our analysis of broker-based forecasts did not strengthen much over February but they did stay solid and stronger than those for the ASX 200.

We believe the market will continue to improve once the coronavirus situation is resolved. The US election issues could mask market movements up until the Democrats have a clear leader to challenge Trump in the November election.

Bonds and Interest Rates

The Reserve Bank of Australia (RBA) was on hold in February but flagged that they were ready to act if necessary. The Bank of Korea, at their end-of-February meeting, kept rates on hold at 1.25% despite there having been strong market predictions that rates would be cut.

The US Federal Reserve (the “Fed”) appeared to be settled at the current rate until the last day of February when the chairman, Jay Powell, came out in a speech to settle down markets. The market has been expecting cuts this year.

Until the stock market sell-off, a standard measure for estimating the chance of rate cuts (known as the CME Fedwatch tool) had priced in only a slim chance of there being a 25bps cut on March 19 at its next meeting. That has now moved to a 0% chance of the Fed staying ‘on hold’ and more than a 90% chance of there being a double cut of 50bps on March 19th.

However, 50 out of 70 economists polled by Refinitiv (formerly Thompson Reuters) just before the market sell-off did not think there will be a US rate cut in 2020. Sentiment is changing on a daily basis.

The US 10-year and 30-year Treasury-note yields reached all-time lows at the end of February. However, the standard measure of observing the 2-year Treasury note yield over the -10-year Treasury note yield (2-10 year spread) not inverted (i.e. the 10-year rate is less than the 2-year rate) that some would use as an indicator of a possible recession.

Other Assets

The prices of oil and iron ore fell over February largely over the China-coronavirus situation. The price of gold rose, then held steady, reflecting its safe-haven status. The Australian dollar reached an 11-year low against the $US in February after falling 3% over during the month.

Regional Review

Australia

The Labour Market Survey for January reported in February showed an increase in the unemployment rate from 5.1% to 5.3%. We reported last month that we thought that the drop to 5.1% was likely to have been a statistical aberration. There were 13,500 jobs added in January with a very strong increase in full-time jobs. The Australian job market continues to be solid.

The Westpac consumer sentiment index rose back to 95.5 from 93.4 in February. The index has not been above the 100 level that separates optimism from pessimism during the current financial year. The Australian consumer, based on the index, is not optimistic but they are still spending.

The RBA is forecasting economic growth to be 2.75% this year followed by 3.0% in the next. We think those forecasts are optimistic but immigration will most probably help keep us well out of recession territory, the caveat being the impact of the coronavirus which is clearly a net negative, it is too early for us to comment on the magnitude of the impact.

China

The coronavirus outbreak has caused major shut-downs in China. There will undoubtedly be a permanent component to the lost production and sales. Importantly, the supply chain for global manufacturing has also been affected.

The China manufacturing Purchasing Manager’s Index (“PMI”) fell to an all-time low of 35.7 (from 50.0) at the end of February. The services PMI also fell sharply from 54.1 to 29.6. Notwithstanding these sharp falls in the China PMIs were largely anticipated.

There was a report on CNBC that the supply chain for certain retail goods was already starting to recover. When there are so many products in so many regions of China, there may be conflicting reports for some time to come.

We understand that China has been collaborating with other countries in the search for medical solutions. Although the quarantining has been disruptive it may well be shortening the length and severity of the problem.

The US labour data remain strong. The number of new jobs came in at 225,000 against an expected 158,000 but the unemployment rate came in a notch higher at 3.6%. The change in wage growth rate returned to 3.1% from 2.9%.

Europe

Italy has so far suffered the most of all European countries from coronavirus. Sporting fixtures and cultural events have been affected.

There appears to be little news on the Brexit front. Perhaps public servants are diligently and quietly working towards new trade deals. We are, at this point not learning of any major disruptions to the UK or EU economies as were foreshadowed during the run-up to the start of the Brexit process. That said, the coronavirus and its escalation in Europe looks to have pushed Brexit to the margin for the moment.

Rest of the World

Japan’s December quarter 2019 growth came in at 1.6% for the quarter while Singapore beat expectations with a growth rate of +1.0% over the same period.

Surprisingly Japan’s industrial output and retail sales beat expectations by a healthy margin. With coronavirus looming large in February and beyond, at least this good start to the pre-virus situation is a much needed positive.

Hong Kong will likely go into recession from the combined impact of the protests and coronavirus. The holding of the Olympic games in Tokyo this year is in doubt. Apparently, there are nearly three months left in which to make a decision. Naturally there would be economic and social consequences of not holding the Olympics as planned.

Economic Update February 2020

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

Good start to year for markets.

– US trade deals signed
– Stronger China data
– Better than expected Australian data.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

We expressed strong reasons for being optimistic about equities in 2020 at the start of this year. The ASX 200 and the S&P then raced ahead in January so much so that our overpricing signals came close to calling the need for a slight correction!

Coronavirus jumped out of the shadows towards the end of January and that was enough to check the markets’ strides. The ASX 200 still gained 4.7% in January while the S&P 500 finished the month slightly down.

At this point, not enough seems to be known about the virus to be able to make a meaningful economic assessment. However, there are good signals that China and the rest of the world are cooperating in finding a solution. Put in the context of other recent medical alarms such as SARS and Ebola, there is no sign yet that markets might not soon start to recover.

Of course, we had the added problem of major bushfires at home to contend with. Even so, our market climbed just about as much in January as in an average full year!

The Phase 1 trade deal was signed as expected on January 15th so that put the stoush between China and the US on the back burner. Brexit seems to be going smoothly – certainly far better than most claimed it would be in the three-year run-up since the referendum.

The Trump impeachment trial started with all of the fanfare of a three-ringed circus coming to town. Few expect a conviction and an exit for Trump. The issue is what impact there will be on Trump and Biden in the run-up to the November elections.

By and large the relevant global macro-economic data in January have been quite favourable. China’s key monthly indicators were stronger than expected. Its economic growth came in as expected at 6.1%.

While some point to a falling growth rate in China, it is prudent to place this change in growth in context. China’s economy has doubled since 2011 while our economy is only up around 20%. That means that the value added for China from an Australian perspective is massive at 6.1% p.a. compared to 8% p.a. or so a decade ago!

The US Federal Reserve (the “Fed”) kept rates on hold in January as expected. However, they did downgrade the word they have been using to describe their labour market from “strong” to “moderate”.

The latest nonfarm payrolls figure came in a little under expectations at 145,000 new jobs for the month of December against the predicted 165,000. The unemployment rate stayed at 3.5% (a fifty-year low) but the growth in wages dropped from 3.1% p.a. to 2.9% p.a.

We have found it hard to be any more positive about the Australian economy than “stuck in a rut” (but not dying). The latest jobs data were, in fact, a little encouraging. The unemployment rate dropped a notch to 5.1% and jobs growth was moderately strong. Indeed, the rate of increase in full-time employment has been (gently) accelerating.

Even our inflation rate hinted at some signs of life. The headline figure of 1.8% and the RBA’s preferred “trimmed mean” number of 1.6% are not far off the 2% to 3% band that the RBA targets.

Importantly, the IMF believes that global growth in 2020 will be 3.4% against 2.9% for 2019. That is, most indicators suggest that the “bottom” is behind us. Cyclical growth can start again!

The upcoming reporting season in Australia will shape the year to come. The US season, already underway, has had some standout successes but also some big failures. Our interpretation of broker-based forecasts of earnings growth in Australia (underpinned by company guidance) has strengthened to level around 5%, enough to support the view that the ‘endless summer’ looks set to continue, the caveat being that the Coronavirus outbreak is quickly contained.

Asset Classes

Australian Equities

There were big gains in most sectors of the ASX 200 in January other than resources. Even Financials posted modest growth.

The January gain for the broader index of 5% is around the long-term average for a full year. We have the market modestly overpriced but the fundamentals have been improving steadily since November.

Importantly the ASX 200 has already climbed above the highest end-of-year forecast we have seen in the media. With the February reporting season just getting underway, we will see if the January surge was misguided or if the commentators will be forced to upgrade their forecasts.

Of course, the full impact of the Coronavirus has not yet fully worked through. When it is difficult to estimate the economic impact of such a health problem, markets often over-correct presenting buying opportunities.

We see no new major downside to the market in the near future but we do expect growth to moderate. The ‘endless summer’ in the markets will one day end but based on our forecasts we do not see sufficient justification to rotate away from equities at this point.

Foreign Equities

The S&P 500 did not fare as well as the ASX 200 during January but new all-time highs were reached in January in both markets. The S&P 500 gave up all of its January gains on the last day of the month – and then a little more.

The December quarter 2019 US reporting season is well underway with the likes of JP Morgan and Amazon spectacularly beating expectations – so much so that the Amazon CEO, Jeff Bezos, reportedly added $11bn to his personal wealth on the day of that announcement. Amazon went on to rally the next day while the broader market was being hit by the Coronavirus.

Of course, there were misses too but our take of the season so far is that there is, on balance, support for this rally.

Bonds and Interest Rates

The US Federal Reserve (the Fed) was on hold in January as was largely expected. Interestingly, the CME Fedwatch tool that prices possible Fed rate changes off futures prices put the ‘no-change’ probability at 87% but interestingly the remining 13% was for a hike and not a cut!

At that time, the same expectations for the period up to December 2020 were only for 26% on hold; 3% for a hike and the rest for one to three cuts. The Fed’s statement said that they expect to be ‘on hold’ throughout 2020 before a new hiking round begins – but at a much slower pace than last time.

After the Fed decision, and the further impact of the Coronavirus, the end-of-year probability for being ‘on hold’ is now only 10.8% with 1, 2 and 3 cuts this year being almost equally likely!

The US 10-year bond rate was just over 1.9% at the beginning of the year but this rate fell to 1.6% at the end of January. However, the 2-year rate also fell so that there was no recurrence of the “inverted yield curve” that worried some in mid-2019.

The Reserve Bank of Australia (RBA) was widely expected to cut rates at the start of February but the recent employment and inflation data reduced that probability a little. We expect a cut in the first half of this year. It is not clear if the RBA will react to the Coronavirus situation.

Other Assets

The prices of oil pulled back over January as some degree of peace returned to the Middle East.

The price of copper also retreated but coal prices posted a modest increase.

Regional Review

Australia

The Labour Market Survey for December, reported in January, showed a fall in the unemployment rate from 5.2% to 5.1%. The consensus forecast was for an increase to 5.3%. However, the sample size for this survey provides for quite a wide tolerance in outcomes.

There were 28,900 jobs added in December but all of those jobs were part time. However, the official trend employment data that smooths out random variations painted a brighter picture.

Our latest inflation data produced a 0.7% gain for the quarter or 1.8% for the year. The RBA prefers to use a so-called ‘trimmed mean’. Those figures were 0.4% for the quarter and 1.6% for the year. Markets had expected 1.5% for the year meaning that inflation is at a more encouraging rate than expected. The RBA is mandated to try and keep inflation in a target band of 2% to 3% (something it has failed to do for a number of years).

While these ‘hard’ data have been positive, the Westpac Consumer Sentiment Index fell from 95.1 to 93.4. That is, there are more pessimists than optimists and 93.4 is at the low end of observations since the end of the GFC.

Going forward, we will start to see data more affected by the bushfires. We expect that, after some volatility in the numbers, government expenditures will return the overall economic data to previous levels.

China

The Coronavirus outbreak in the Wuhan area is a major concern. The World Health Organization confirmed on January 30 that the virus is now classified as a global threat. However, the press release emphasised it might well be contained in advanced economies. It is a far more serious problem for countries with weaker public health systems.

A forecast of China growth reported on CNBC TV for the current quarter was 4.5% which is well below the previous quarter’s 6.1%. Few analysts so far are calling for any long-term detrimental impact on the global economy.

The China manufacturing PMI index came in at 50.0 which was right on expectations. The survey was taken in mid-January while the virus was only just emerging. The next reading could be well down.

China Industrial Output (6.9%), Retail Sales (8.0%) and Fixed Asset Investment (5.4%) all beat expectations.

The US labour data remain reasonably strong. The number of new jobs came in at 145,000 against and expected 165,000 but the unemployment rate again came in at a fifty-year low of 3.5%. The change in wage rate dropped from 3.1% to 2.9%.

Retail sales were on expectations at 0.3% for the month but housing starts stormed home at +16.9% to a 13-year high. Q4 growth came in at 2.1% just above expectations.

Trump signed the Phase 1 trade deal with China and also the replacement of the North America Free Trade Agreement (NAFTA) arrangement between the US, Canada and Mexico. Canada’s president Trudeau is yet to sign this new United States Canada Mexico Agreement (USMCA).

Neither trade deal is thought to provide a major direct improvement to trade but they do take away a lot of uncertainty that had been clouding investment decisions.
The impeachment trial in the Senate is underway. Few expect the economy to suffer or for Trump to be forced out of office. However, it may well impact the prospects for Biden and/or Trump in this year’s elections.

Europe

Brexit is at last underway. So far there is much less negativity about the economic consequences than during the run-up to Brexit which occurred at midnight local time on 31 January. The UK now has until December 31st of this year to cobble together some new trade deals with Europe and the rest of the world. During this transition period it may well be the case that the UK puts together some temporary deals while better longer-term deals are negotiated.

The Bank of England kept rates on hold in a 7-2 vote of the policy setting committee. Most expected a cut or at least a much closer vote. We take this vote as a positive from the Bank.

Rest of the World

The IMF shaved 0.1% off its forecasts for global growth in 2019 and 2020 to 2.9% and 3.4%, respectively, because of their perception of the India economy. The important take away is that the IMF still expects 2020 to be noticeably stronger than 2019. Perhaps the next cyclical upswing is underway – notwithstanding the Coronavirus outbreak. Naturally Q1 of 2020 might see a health-related pullback in growth delaying the start of this next upswing.

Economic Update – January 2020

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

Optimism for share markets in 2020.

– Equity markets offer good growth and yield opportunities
– US-China tariff deal could be big news
– Clarity over Brexit gives more growth prospects.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.

The Big Picture

Before we launch into our set of predictions for 2020 and beyond, it is worth reflecting on the decade that just ended.

The ASX 200 started the decade at 4,871 and it ended at 6,684 – or 37.2% higher. That amounts to an annual growth rate of 3.2%. Not great but it beat cash. When dividends are included, the growth turns out to be 113.2% or 7.9% pa. Of course, many Australian residents also received franking credits possibly adding over 1% pa to that growth.

Along the way, investors had to duck for cover as many commentators predicted several ‘hard landings’ for China, recessions in the US and the world and numerous other false signals.

The S&P 500 did even better than the ASX 200. It started the decade at 1,115 and ended it at 3,231 for a growth of 189.7% or 11.2% pa. With dividends, that growth rate rises to 13.6% pa. Of course, Australian investors may have also benefited from the 22% fall in our currency over the decade depending on how their overseas investments were managed.

We are still positive for equities going into 2020 but there are some false signals that need to be considered. Capital gains in both indexes were very strong in 2019 [ASX 200, +18.4%; S&P 500; +28.9%] but here the context is important. The US Federal Reserve (“Fed”) frightened markets in early October 2018 sending markets sharply lower. It so happens that the reaction was unnecessary as the Fed reversed its comments over the following months. The markets bottomed around the end of 2018 so the 2019 gains included ‘fundamental’ growth plus the correction of the earlier over-reaction.

Our estimates put the actual fundamental growth in 2019 at only a little over average rather than stellar. Our forecasts for both markets in 2020 are again just above average (before dividends). With bond yields and cash rates expected to continue at around the current low levels, equities are likely to be about the only way to earn both yield and growth in 2020.

Every year produces market surprises which are unpredictable. However, we can suggest some other possible sources of known possible surprises and whether these are more likely to be positive or negative.

The phase 1 deal in the China-US tariff war is likely to be signed very soon and this would be a strong positive for US and global growth if both sides stick to it. With the presidential election in November, Trump is incentivised to keep the deal on track.

The Fed has stated that it will keep rates on hold in 2020 while markets are still pricing in a possible single cut. Certainty in understanding and believing the Fed is always a positive. Our scenario for 2020 is continued low bond yields and cash rates.

The recent landslide victory for Boris Johnson’s conservative party in the UK will almost certainly end the three and a half years of Brexit woes with a clear break from the EU in January. There is plenty of positivity about possible new trade deals with the US, Australia and a temporary deal with Europe. There is no talk of major moves of international banks from London to Europe as were once predicted.

Since Johnson is likely to help the transition with fiscal stimulus, the UK and Europe could be in much better shape in 2020 than the last few years.
China economic data have turned the corner and we expect a solid post-tariff-war growth from China.

Australia remains in sluggish economic times. However, growth and jobs are solid – just not strong. The Reserve Bank is likely to cut its rate again – at least once in 2020.

We will tease out these predictions – and others – in the sections that follow. Unlike in past years, none of the main economic known situations seem likely to be negative for markets – but, of course – there is always the completely unexpected!

Asset Classes
Australian Equities

Big banks suffered later in 2019 over the Westpac money laundering scam and other banking crises. Financials lost 6.0% in the second half of 2019 (H2) while the broader index rose +1.0%. Telcos losses were even worse than Financials with a loss of 8.2% in H2.

The banks are currently cheap but uncertainty over possible future revelations makes heavy investment in them bold to say the least.

All sectors had a bad last two days of 2019 but that is more likely attributable to profit taking and accounting creativity at year end. There was no bad news to speak of and volumes were low. Materials had a strong December rising +1.5%. The ASX 200 lost 2.4% in December.

Foreign Equities

The S&P 500 is currently overpriced by our measurements. Making our fundamental projected growth (+11%) more like an actual 7% or so when current mispricing is factored in. A year ago, we had mispricing at about 15% which helped fuel the ‘stellar’ headline returns of 2019.

The Health sector of the S&P 500 had a spectacular year in 2019. If the Democrats are elected, that could put downwards pressure on Health stocks. Either way the main gains seem to be behind us.

While the ASX 200 went backwards in December, other major indexes did very well: S&P 500 (+2.9%), FTSE (+2.7%), World (+2.7%) and Emerging (+5.9%).

Bonds and Interest Rates

The Fed was on hold in December and its so-called ‘dot plots’ that represent members’ forecasts showed the Fed to be on hold for 2020 with one increase in 2021 and one more in 2022.

The CME Fedwatch tool that prices possible Fed rate changes off futures prices puts the chances of a ‘no change’ outcome in 2020 at above 50% but this figure moves from day to day. There is little or no support for a hike and one (or possibly two) cuts is expected by the market.

The RBA was on hold in December and does not meet in January. Many, including us, think there is at least one cut left in the RBA. Previous talk of QE by the Bank has subsided but they might do something creative in 2020.

Other Assets

The prices of iron ore, copper and oil all had a very strong month in December. Our dollar appreciated +3.4% against the US dollar taking it back above 70 US cents for the first time in a while.

The Saudis appear to be working hard to get a stable equilibrium price for oil. It has been suggested that the Saudis need the price of oil above about $80 / barrel to balance their budget but Russia can make a profit at $50. Interesting times!

Regional Review
Australia

Our Q3 GDP growth figure came in at the low end of expectations in early December – just after the RBA kept rates on hold.

The quarter on quarter growth was +0.4% which, over the year, turned out to be +1.7%. Since that annual figure was the same as population growth – both natural and through immigration – the per capita growth was 0.0%. Hence, we are going nowhere towards building a stronger economy but, at least, we’re not going backwards!

Our jobs data were quite strong suggesting the quality of the jobs in contributing to growth must have been poor. The unemployment rate fell one notch to 5.2%. A recession does not seem to be on the cards but there is a strong case for the government providing a fiscal stimulus to accompany the work the RBA has at last been doing on rates.

However, for political reasons, the government is wedded to producing budget surpluses. The whole point of fiscal management is to run at a deficit when the economy needs a boost and to pocket the savings when the economy is stronger.

The good news is that the official Australian Bureau of Statistics house price indexes showed a strong bounce in Q3 after a couple of years of falling prices. These data corroborate earlier monthly data released by private agencies.

The house price index went up by +2.5% for the nation in Q3 but about +3.5% for each of Sydney and Melbourne. House price increases are often associated with a boost in consumer confidence through an increased home equity cushion.

China

We reported last month that the Chinese economy started to show signs of weakening. However, the four major economic indicators that we used for that assessment were all strongly up this month and, indeed, were a beat on expectations.

The latest Purchasing Managers Index (PMI) for manufacturing came in at 50.2 for the second month in a row and above the expected 50.1. Manufacturing is not kicking the ball out of the park at just over the 50 level which separates contraction from expansion, but it is growing. The services sector is doing the heavy lifting.
China is removing some of its tariffs on US imports and seems to be embracing the phase 1 trade deal with the US.

In 2020, growth is likely to dip below 6% for the first time in well over a decade. Unlike some, we think that is not an issue to necessarily worry about. In fact, we view it somewhat positively. The context for this view is that, a decade ago, the Chinese economy grew at around 11% p.a. to 12% p.a. But China’s economy has approximately doubled over the last decade so, 6% now is producing the same dollar value increase in GDP that 12% growth achieved a decade ago. The growth rate of all economies slow down as they reach maturity. One day China will grow at rates in the range or 2% to 4% like the US does now – and that will be a good thing for the global economy, all else being equal. Of course, if sub 6% was the result of weak economy rather than a maturing economy, that would be another story – but it isn’t.

The impeachment issue has taken up too much space. An impeachment is only the equivalent of an indictment in criminal law. An indictment means that a case for trial has been made. The judge and jury then decide guilt or otherwise – after the case is argued properly.

The impeachment vote went almost along party lines in the (lower) Democrat-held House. All Republicans voted against impeachment but three Democrats crossed the floor to join the Republicans! Since a 60% majority is needed to sack the president in the Senate and the Republicans have a majority in the Senate, it is extremely unlikely that Trump will be sacked.

What is interesting is that Nancy Pelosi, the Democratic leader of the House, is not sending the indictment up to the Senate – at least not yet. She must know she will lose and it is election year. Presumably she has a plan to eke out some political mileage but we do not know what that plan might be.

Many say – and we probably agree – that a sitting President gets elected when the economy is strong. US jobs bounced back strongly last monthly but partly because 46,000 GM workers went back to work after a strike. Either way, the unemployment rate is at the 50-year low of 3.5% and the wage rate increase sits at a reasonable 3.1%.

Now that Trump has the China deal in motion and the new North America Free Trade Agreement (NAFTA) with Mexico and Canada looks set to be implemented, Trump looks to be successful on trade. We do not believe the gains made in these negotiations are great but they are getting the sound bites. There doesn’t seem to be long enough before the election for things to go significantly wrong. Indeed, the trade deals might cause a nice expansion into 2020. There are some people that might not like Trump for a myriad of reasons but he is the poster boy of a strong economy.

If we go back to the 2016 election, a bunch of Nobel Laureates (yes, in economics) said (as we reported at the time) there would be a recession as a result of Trump’s election and his policies. They didn’t actually say when but that ship is taking a very long time to sail, and clearly has not sailed yet.

In mid-2019 many economists (most without Nobel Prizes) argued that because the short-term US interest rate was higher than the long-term interest rate – a so called yield-curve inversion – a recession would follow in 12 to 18 months. That point was laboured in the media for months but now the proponents of that view are scarce.

As we wrote at the time, economic life is far more complicated than looking at a few simple statistics and crying ‘wolf’. Indeed, their thesis on recessions was that an ‘inversion’ is all that is needed – so that the now normal yield curve does not remove that so-called prediction accuracy! If those forecasting a US recession 12 to 18 months after the occurrence of the yield curve inversion were true to their beliefs they would still be arguing for this outcome – but they’re not!

With the Fed and markets at last (more or less) in harmony it is difficult to see anything less than at least a slight boost to the US economy. That, in turn, would mean a boost to company earnings and a boost to the S&P 500. Our forecasts are based on current broker forecasts of earnings, which we use as a directional guide, so we might see further upside in corporate earnings in the coming quarters.

Europe

Readers might recall the media were telling us that the UK electorate was duped over the Brexit referendum. “They didn’t know what they were voting for” and “they will vote the other way if they get a second referendum”. So much for the media! Boris Johnson made Brexit THE election issue and he won with a landslide victory – by 80 seats.

Conservative Party leader Boris Johnson expelled more than 20 disillusioned sitting members before preselection ahead of the ‘BREXIT’ election, in so doing creating a massive united mandate within the Conservative party. We were told from various exit polls that lots of hard-line Labour voters switched to voting Tory by “lending” their votes for Brexit. The implied intention is that these latent Labour voters will return to their grass roots of Labour in five years’ time – after Brexit is locked in. So much for ‘duped’ voters.

It is not for us to judge whether the UK should be in or out of Europe but it is blindingly obvious that the uncertainty has confused investment decision making with respect to the UK and, hence, growth. Trump and Australia seem to be making plans to initiate trade deals with the UK and Europe might now be forced to think that way as well. The CEO of Morgan Stanley, a major international bank, stated publicly that they are not moving any significant numbers of people to Europe from London – a far cry from earlier speculations.

Rest of the World

Japan is launching a $120bn stimulus package as the ‘third arrow’ of the Abenomics initiative when Abe came to power in December 2012. It seems that nothing they do gets inflation working and nor for that matter has any other major economy been successful in creating inflation either.

Christine Lagarde, the new president of the European Central Bank, who reportedly has no training in economics nor experience in banking, has recently stated that she is thinking of changing the inflation target for Europe. While that approach has the appearance of simplicity it has not received meaningful support from leading economists. The concern is that Europe is too big of an economy to let itself off the hook by conveniently moving the goal posts.

Economic Update – December 2019

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

Optimism pervades year end

– Collective opinion that a US recession was imminent vanishes
– US Fed firmly on hold
– Westpac gets caught up in money laundering scams

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

A TV segment aired on CNBC (November 25th) declared that the recession fears starting on August 14th had been set aside. Readers might recall that we never thought the so-called ‘yield curve inversion’ phenomenon that started this round of fear had any merit. As a result, our investment strategy has been unchanged during this three-month period while some others had to correct their thinking twice.

We, of course, know we can make the wrong call from time to time so we do not stubbornly hold on to a position. Rather, we take heightened interest in all other signals and arguments until the scare passes.

With the US Federal Reserve (“Fed”) firmly on hold for the foreseeable future, the tariff war abating, and the official US GDP growth being revised upwards from 1.9% to 2.1% for Q3, there is less to worry about into the end of the year.

We do have to keep an eye on the proposed December 15th tariff hikes flagged by Trump. The consensus is that they won’t take place at all or will be scaled back.

While we agree that Trump will get a Phase 1 deal done some time, we now don’t think he will want to do it too quickly. Rather, he might like to keep the window between a deal and the election in November short enough so as not to allow for any close scrutiny of the merits of the deal before the vote.

The US jobs data released in November were much better than expected but expectations had been set particularly low because of 46,000 GM workers being out on strike. There was no value in that data outcome but wage growth was stronger and the unemployment rate stayed close to the 50-year low.

Moreover, US housing data were strong and retail sales beat expectations. Three large retailers (Target, Lowes and Macy’s) reported earnings much better than expectations. The US consumer remains strong and the consumer accounts for about two-thirds of the US economy.

At home, some greeted our jobs data with a heavy heart. While total employment did fall for the month, the headline data is quite volatile. The official trend data was not only for jobs growth but a slight uptick in that rate of growth.

Scott Morrison flagged an acceleration of $3.8bn worth of infrastructure spending but announced no new tax cuts in the near future. The Reserve Bank is thought to be considering monetary stimulus measures including rate cuts as the Australian economy continues to experience anaemic GDP growth.

The stock market was rocked by Westpac having had 23 million breaches of the money laundering rules. All four big bank stock prices took a hit on the day and for some days to follow. Since the banks are about one third of the ASX 200, lots of investors were affected. Nevertheless, the ASX 200 came within a whisker of a record 6,900 at the end of the month.

For a change, the news from Europe was encouraging (or at least less discouraging). Germany avoided a recession and a general election in the UK was called for December 12th. The incumbent Tory party, led by Boris Johnson, is well ahead in the polls. While there is now less faith in the accuracy of polling, it looks quite possible Johnson will get an absolute majority (unlike the present government that relies on a number of Northern Ireland MPs) that might help force a conclusion to the Brexit situation.

Whether or not Brexit is a good idea, the current uncertainty about the future of the European relationship is crimping investment intentions.

With the S&P 500 and the ASX 200 recently hitting new highs, and views about future policy changes are moderating. We continue to hold our view for modest to moderate growth in both markets while interest rates will remain low for some time.

Asset Classes
Australian Equities

The ASX 200 had a strong month recording gains of around 3%. The Financials sector fell around 3% over the month because of the Westpac crisis. Most other sectors did very well indeed. We have the index only a fraction over-priced. Accordingly, we continue to maintain our focus on earnings quality and await a pullback in market index levels before we consider bailing out of this major bull-run.

Foreign Equities

The S&P 500 also had a strong November gaining around 4%. The world index grew around 3% in November. We also have the S&P 500 only a fraction over-priced.

Bonds and Interest Rates

The Fed made strong statements about future rates in the US. It claims that economic growth is moderate, jobs are strong and inflation is near its 2% target. Therefore, it will take a lot for the Fed to cut rates further. However, there seems little chance that rates will rise for a substantial period. The market is now pricing in future rates broadly in line with the US Federal Reserve.

The RBA elected to leave the cash rate unchanged at 0.75% at its last meeting for the year. However it is also considering some kind of QE (quantitative easing) program similar to what the US and Europe engaged in following the GFC but Australia avoided.

Other Assets

The prices of iron ore, copper and oil all firmed in November. Market volatility – as measured by the VIX – fell sharply over November to a below average reading indicating that markets are experiencing reasonably healthy investor support.

Regional Review
Australia

The government will report its mid-year fiscal position (MYEFO) in December – shortly after our Q3 GDP growth data are released.

There is little doubt that the Australia economy has been subdued for much of 2019 but it does not seem to be slipping further. Rather, policy settings have stabilised the economy but a boost i.e. Government spending would be welcomed. If the government indeed fast-tracks the $3.8 bn infrastructure package, and the RBA eases monetary policy, the Australia economy could be in good shape towards the end of 2020.

China

The Chinese economy did start to show signs of weakening during November. Most of the major statistics missed expectations. Perhaps the trade war is starting to bite. As a result, China might be keener to resolve the trade war than before. Also, the civil unrest in Hong Kong continues but does not appear to be escalating as it did previously. The local elections saw a significant swing to pro-democracy candidates making the leadership of Carrie Lam more problematic that previously.

US

Several key US economic indicators beat expectations in November. In particular, US GDP growth of Q3 was revised upwards from the preliminary read of 1.9% to 2.1%. Those who were predicting a US recession earlier in the year must now be questioning their views.

Moreover, a number of agencies and private banks are staring to predict 2020 and 2021 will be stronger than 2019. That is, they believe that we are now at the bottom of the cycle. We concur but we do not feel the need to predict more than 12 months ahead to prudently manage our investment strategies. We also note that just because the cycle may have bottomed, does not imply that the recovery is imminent. Observations of this current cycle are that it is very slow moving.

Bloomberg, the financial services company, has just started to produce forecasts of a possible US recession over the following 12 months. Their first estimate puts the chance of a recession at 26% which is low for any given year. We will continue to monitor this indicator in order to assess any value it might have as an input to our strategies.

Europe

The UK will elect a new government on December 12th. Polls have Boris Johnson about 10 points clear but recent votes in many countries have called into question the accuracy of such polls.
If the Conservative Tory party gets an absolute majority it might well be able to push its Brexit policy through parliament and resolve Brexit by the next (January 31st) deadline.

Business seems to be battle-weary after three years of negotiations. Any sensible resolution to Brexit might prove to be a boost to that region’s economy.

Meanwhile, Germany just avoided a recession by producing a growth +0.2% in the latest quarter.

Rest of the World

The US has now declared its support for the Hong-Kong pro-democracy movement. While that might have a negative impact on the mainland China government, it might assist to produce stability on the streets of Hong Kong.

Japan’s economy continues to limp along. The latest Q3 growth was only +0.2% and industrial output growth was sharply negative. However, investment intentions for next year received a boost in the latest survey.

Economic Update

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