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

Markets keep on roaring!

• Trump makes progress on several fronts
• RBA changes its monetary policy stance
• China delays coal imports

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 us.

The Big Picture

For the second straight month, major stock markets around the world made impressive gains. While some express the opinion that this rate of growth is unsustainable, we are of the opinion that nearly all of these recent gains just take us back to September – before the US Federal Reserve (the “Fed”) chair made comments that sent markets into a tailspin. 

Since we have markets once again about fairly priced, we believe that the ASX 200 and the S&P 500 can continue to grow from here – but at a more modest pace – as if the October-February period had never happened. 

Of course, Trump’s dealings over trade with China, his “Wall”, and the US government shutdown contributed in part to market volatility. The shutdown is now behind us as Trump compromised on the level of funding – only to lodge an emergency order for the rest. 

While there are social issues concerning the Wall, there should be no major economic impact for Australian investors from here over its possible construction or funding.

China has agreed with making some changes on trade with the US. Trump removed the March 1 scheduled uplift in tariffs from 10% to 25%. A meeting between Trump and Xi in Florida is mooted for late March.

It is unlikely that Trump will get all he wants anytime soon but a start will be seen as a win for both sides. There have been issues with intellectual property (IP) and IT for decades so that won’t get sorted quickly. China has agreed to certain policy moves on its currency and increases in agricultural imports from the US.

The US jobs data were again particularly strong but some other data were weaker. There are major statistical issues in trying to interpret a vast array of data on a monthly basis. For example, Retail Sales for December were a major miss on expectations. But the massive retailer, Walmart, blitzed the market with its latest quarterly report released in the same month. Go figure!

The Fed has been very careful in managing expectations in recent times. It has even downplayed its moves on reducing debt levels. It seems unlikely that investors have anything to fear from the Fed in 2019.

The RBA kept rates on hold in Australia but, importantly, acknowledged that the next move in rates is as likely down as up. For two years it has been arguing that “the only way is up”.

We have argued over this same period that cuts would be beneficial and now we think we at last should get two this year – and the first one pretty soon (now that the RBA has softened us up!).

The Royal Commission into Financial Services largely left the banking structure intact. Mortgage brokers and some insurance businesses were, however, affected.
Our jobs report was also quite strong – more than 65,000 new full-time jobs were created in January. The real problems are not yet self-evident. We believe that future growth in Australia will be limited by the running down of household savings. Our savings ratio is close to pre-GFC lows and so we must pull in the purse strings.

In Europe, the UK is taking a line which might result in a delay to Brexit or, indeed, a second referendum in an attempt to forget the whole exit process. Both the Bank of England and the EU have downgraded their economic growth forecasts for 2019 but both are still comfortably above 1% pa.

We conclude that the political and economic backdrops are more conducive to market growth than they have been for many months.

Asset Classes
Australian Equities

The ASX 200 put in a strong month in January at +3.9% and backed that up with a +5.2% in February. Given that the long-run average capital gains in this market are about 5% pa, these numbers are big. But when the index falls in the fourth quarter of 2018 are taken into account, we are just back to around September levels.
The bank stocks did particularly well after the Royal Commission ended without any major impost on the banking structure.

The defensive Consumer Staples sector ( 2.3%) was the only one from 11 of the key industrial sectors to go backwards in February. The market is looking for risk and growth again! The 2018/19 y-t-d is well back in the black (+2.6%) when dividends are included.

Foreign Equities

All the major indexes put in a strong February and the ASX 200 was at the head of the pack – possibly because of the bounce in banks after the end of the Royal Commission.

Despite the massive gains on the S&P 500 since Christmas Eve, we have that market currently about fairly priced. 

Bonds and Interest Rates

The CME Fedwatch tool for pricing possible rate changes in the US is now set at about 6% for a cut in 2019, 4% for a hike and 90% on hold. Sentiment can and does move quickly.

The RBA was on hold in February but we think it is likely to cut a couple of times in 2019 after Governor Lowe’s statements flagging a softening of the hiking stance. Westpac has also publicly stated a forecast of two cuts in 2019.

Other Assets

The prices of copper and oil received a big boost in February. The prices of gold and iron ore were flat.

Regional Review
Australia

The jobs report in February was one out of the box. In recent times, expectations are usually for around 10,000-20,000 new jobs to be created each month. After a strong report in January, 65,400 full-time jobs were created in January. This was offset by a fall of  26,300 part-time jobs but who wouldn’t trade full for part time if that’s what the employee wants.

Wages growth did miss at +0.5% for the quarter compared to an expected +0.6%. Wage increases are barely beating inflation.

As the general election nears, the polls are changing rapidly. While there are many important issues at stake, it does appear that the Labour party’s policy of reducing franking credits and increasing capital gains tax are not popular. While we take a neutral position on politics, changes to how we should invest are inevitable if the status quo no longer applies.

China

China has been forced to the table over trade and IP protection. Whatever people think about Trump – the man – the President of the US has made inroads into the problems that are at hand.

The issues are immense. Not just trade and IP, but ‘owning’ the South China Seas and more are critical for a strong future for the world order. If the West does nothing, the position might deteriorate. But if the West tries to move too quickly, old folk know only too well what life could then be like. Just remember the public fear surrounding the ‘Bay of Pigs’ showdown in 1962 (Kennedy v Cuba) to know that we never want to witness such situations again. 

China is agreeing to some changes and that is why Trump did not impose round two of the tariff hikes scheduled for March 1. The China Purchasing Managers Index (PMI) a measure of changes in industrial demand stands at 49.2 from the previous month’s 49.5. It is below 50 but, as an expectations survey, it is likely to be affected by the US-China trade talks discussions.

US

The US government shutdown ended with a compromise on the “Wall” funding. The March 1 tariff hike was averted and Trump went to Vietnam to have a summit with the North Korea leader, Kim Jong Un. 

Some say that Trump has achieved nothing on this front but we wrote 15 months ago or more that Kim was trying to fire missiles over Japan – and the only good thing was they failed to get out of his territory. There have been no tests in the 15 months since that dialogue started. The problems, as with China, cannot be resolved overnight but the groundwork is being laid.

Trump did walk out on the Hanoi summit which was applauded by both sides of the aisle in the US Congress. Trump is not being bullied into a “bad deal” just to get a deal signed. The US Secretary of State has since confirmed negotiations are continuing. 

We still think the US economic slowdown is still being oversold. GDP growth of 4.2% for Q2 was a high but a recession is not expected any time soon. The latest GDP growth for Q4 was 2.6% which exceeded the market expectations of 2.2%. This growth equated to 3.1% for 2018.

Europe

The Brexit debate has taken a turn with the UK PM, Theresa May, going back to parliament to renegotiate. The March 29 deadline is so close that some are wobbling at the knees. We do not pretend to know how the process will end but it does look like, as we always expected, that some sort of common sense will prevail.

The Bank of England cut its growth forecast from 1.9% to 1.3% for the current year. The EU cut its forecast from 1.7% to 1.2%.

Rest of the World

Since the Radcliffe line was hastily instituted in 1947 to split “British India” into Pakistan and India, the peace has never been settled. Towards the end of February, both sides were shooting down each other’s military planes. At this stage the fall out to markets seems limited but all international conflicts must be taken seriously.
On a more frivolous note, Fox (US) TV was commentating on the (then) impending summit between Trump and Kim. The anchor stated that Trump had to fly half way round the world for the meeting but Kim “just had a couple of hours train ride” to make!

As the crow flies, North Korea is more than 3,000km from Hanoi so it seems like a train would take much longer to get there that a plane for Trump from the US!

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

Markets roar back to life!

Federal Reserve clarifies its position

China data were weaker than expected

Australian rate cuts on the horizon

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
We reported last month that we had the Australian and US stocks markets as being meaningfully under-valued. Well they are much less so now after a very strong rally during January.

The turn-around in markets started straight after Christmas and gained momentum throughout January as the US Federal Reserve (“The Fed”) made increasingly dovish tones – so much so that the chance of a rate hike this year is now estimated by the market to be minimal. A chance of a cut this year now has gained some support among the analyst community.

The end of January Fed meeting produced a no-change result on rates and the chairman emphasised the word “patience” in his press conference about the timing of future moves. The accent is once again firmly on “data driven” policy changes rather than following a pre-set course.

The US-China trade stoush took a few more twists and turns. The threat of more tariff increases looms large but could well be averted. The China economy is clearly in need of avoiding that situation and so some solution may come soon. China did offer to reduce the trade balance with the US to zero over the next 6 years, however, more needs to be done to address what is characterised as the rampant abuse of intellectual property rights.

US employment data series were particularly strong. A much bigger than expected 312,000 new jobs were created. Unemployment came in at 3.9% pa and, importantly, wage growth was a far more respectable 3.2% pa. The weakness in the US economy mooted by some does not seem to be showing through in the data – at least not yet.

China inflation data – both consumer and producer variants – came in weaker than expected. GDP growth was 6.6% for the year – which was on expectations – but import and export data were weaker.

The weakness in China data is nowhere near as bad as some are making out. There is a natural progression from the double-digit growth of a decade ago to more moderate levels as any country matures. The Chinese government is putting in place policies to combat any slowdown so we do not see modest softness in GDP growth becoming a problem unless Trump brings the next round of tariff hikes into play.

At home, the biggest change has been the attitude towards possible rate cuts by the RBA. This was almost unheard of a month or so ago but the muttering has become louder. Indeed, one leading analyst reported a 36% chance of a rate cut this year.

One reason for a cut is that the NAB and ING just finished the out-of-cycle home loan rate increases. The second is that our CPI inflation data has been persistently lower than the target band of 2% to 3%. The latest reading was 1.8% making it 15 out of the last 17 quarters that the rate has been below the target range.

The RBA has a dual mandate. First it must try and keep full employment. At the current 5% that could be said to be have been fulfilled as there is no prescribed number. The second is to keep inflation within the target band. The RBA has failed in that regard – even in any ‘average over the cycle’ sense.

Our employment data was quite strong again this month but, as always, our immigration numbers helps underpin that and more generally economic growth.

In short, the US Fed has learnt its lessons from making last October’s ill-advised comments. If Trump can be a little more compliant, the US does not seem to be an issue – and neither then would China. And if/when we get a rate cut (or two) from the RBA, we’ll be doing better too. We reiterate our view that Australian and US stock markets barring any unforeseen events are forecast to have an average year of returns in 2019 – with the balance of risk to the upside.

Asset Classes
Australian Equities

The ASX 200 put in a strong month in January at +3.9% with Energy stocks (+11.5%) leading the way. However, the Financials sector, under the weight of the Royal Commission, produced a capital loss of 0.2%.

We have the index only slightly under-priced at this point but our forecast of capital gains for the next 12 months has risen slightly as the February reporting season approaches. Brokers have been modestly increasing their earnings forecasts.

We do not see a return to the 2018 peak through the forecast period but all being well it is not out of the question that we could see it by the end of the year.

Foreign Equities

All the major indexes put in a strong January with Wall Street’s S&P 500 gaining +7.9%. Even Emerging Markets put in over 6%.

In contrast to the ASX 200, we have the S&P 500 sufficiently under-priced to continue the January rally for a little while longer.

Our 12-month capital gains forecasts for the S&P 500 (based on broker forecasts of earnings and dividends) did start to slip a little into the end of 2018 as a pall of gloom started to collect over Wall Street. However, the Q4 reporting season, which is still underway, has given brokers the confidence to reverse some of those calls. As a result, our index forecast strengthened a little – and has stabilised.

Bonds and Interest Rates

The Fed has started 2019 on a clear path to maintain patience over any rate changes and that has pleased markets. A reasonable chance of a cut this year is now being priced in however important to note that any rate adjustment will be data dependent. But noteworthy that the attitude of the US Fed has softened somewhat and they now look to economic data to guide rate policy.

There is now also a significantly greater chance of a rate cut this year in Australia. Such a cut would act to offset the big four banks out of cycle rate hikes of recent times and possibly help promote inflation into the 2% to 3% band.

Other Assets

The prices of iron ore and oil surged by more than 15% each in January. Those increases helped support the January rallies in resources stocks.
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Regional Review
Australia

Australia is inching towards its next general election and with the May budget looking like returning a small surplus both sides are offering sweeteners to the electorate. It is not clear that such expenditures are in the best interest of the economy’s long-run growth path.

There were 21,600 new jobs reported in the last Labour Force Survey which is strong. However, all of these jobs and more were part-time. Full-time jobs shrank by 3,000.

If the RBA does cut the official cash rate soon, that could give a small boost to housing sentiment and the economy in general.

Interestingly, in the days before the Royal Commission hands down its findings, a new bank, Volt, has been given a full banking licence. With the increasing tendency towards internet-based payments systems, the big four’s customer base is at risk of being eroded over time.

We again emphasise that the economy is not ‘in trouble’. Rather, it is just not performing as it could. That said, we do not see a recession on the horizon in 2019.

China

China’s economy is rapidly approaching the size of that for the US – and the US is not happy about that. With economic size comes political power. It is, therefore, important that the global powers assist China in transitioning to the number one slot without upsetting world order.

Trump is trying to do his bit with trade policies. They may not be fashioned in the best way but it is a start to getting China to respect intellectual property rights and also behave in a way that fits in within a cohesive World Trade Organisation (WTO) type framework.

The near misses on the economic data front are not a major issue. It is not possible to guide any economy in a perfect trajectory. We see the Chinese government acting in appropriate ways over 2019 to ensure a stable outcome. That is, of course, unless Trump takes the tariff war too far.

US

The stand-off between Trump and the US Congress did not make any significant gains during January. The partial shutdown of the US government is due to switch back in quite soon and the debt ceiling debate will loom large in about six months.

Whatever we think about the US political process, the hard-economic data are quite good. GDP growth has been strong and jobs growth has been even better.

It is not possible to predict what Trump will do next but he does not have a free hand – especially with this new split Congress. Some compromise on the ‘wall’, and a ‘fig leaf’ from China on trade could have a big positive impact on economic prospects for 2019.

Companies reporting quarter four 2018 earnings at the moment have been a little mixed but there have been lots of very strong results – hence the positive stock market reaction.

Europe

The Brexit issue rolls on and on. It now seems quite likely that, in effect, the March 29, 2019 deadline for the Brexit might be pushed back until later in the year.

The German economy has spluttered a bit in recent months. German car manufacturers are suffering from the US trade tariffs but the impact on Australia is muted.

The Big Picture

The ASX 200 spent April toying with the idea of breaking through 6,000 – and breaking through is oh so different from staying above 6,000! We have now had five surges before retreating back to just under the elusive 6,000 figure and this has occurred within the last two months. But that isn’t a problem – it is normal market behaviour. We have the market priced at around 5,850 so we will likely get to 6,000 one day soon – and stay there come the second half of the year.

After iron ore and oil prices tumbled over 2014, there have been impressive bounce backs in both of these commodity prices. We have argued previously in this update that both prices were being manipulated by the big three miners for iron ore and OPEC for oil.

While the doomsayers were predicting the end of the world, iron ore prices surged from around $US47 per tonne mid-April to above $60 before a small end-of-month sell off. Brent oil (the world price) started April at $US54 per barrel and reached as high as $66.76 at the end of the month.

Naturally, these commodity price movements helped stocks in the resources sector of the ASX 200 but some high yield stocks came off a bit in price as some investors rebalanced their portfolios.

The big fall at the end of April (just after the fifth bounce below 6,000) of ???109 points in one day – only to be followed by a fall of ???49 points on the next/last day – certainly brought some investors to their senses. We would rather the market frequently have these ‘baby’ corrections rather than having blasted through 6,000 only to fall back to 5,000 because of a bursting bubble. After the big fall that occurred on the 29th April, the market finished 12 points below our previously-held estimate of fair value of 5,850 – just 60 points above where the index finished in April.

The Reserve Bank of Australia (RBA) kept rates on hold against the odds after its early April meeting. The market had priced in a 75% chance for the RBA to cut its rate by 0.25%. Naturally, the market immediately priced in the next cut for the May 5th meeting with equal gusto – but the change in direction for commodity prices in subsequent weeks have dampened expectations for a cut in the immediate future.

But most analysts seem to be calling for at least one more cut this year from the current 2.25%. However, 2% is seen as a psychological barrier for many making only one cut slightly more likely than two.

The Governor of the RBA, Glenn Stevens, gave a speech at the end of April pointing out that monetary policy – such as varying interest rates – has done just about all of the work it can for the economy. It now needs the government to create a particularly good budget in terms of creating confidence and growth.

The Governor also pointed out that retirees are worse off than those from a decade ago in terms of finding almost risk-free yields from which to generate a stable income (but many do have 10 extra years’ worth of compulsory super savings to help out!) . And he emphasised that this situation is likely to last for a long time. The importance of investors – in this low rate regime – discussing investment strategies with their advisors is becoming increasingly important. But we are not alone. Low rates are a global phenomenon.

Foreign Equities

It took 15 years, but the NASDAQ (the US ‘tech’ index) at last reached a new all-time high. Of course the dot-com boom and bust of 15 years ago was fuelled by some companies listing for the first time (known as IPOs) on the stock exchange with no earnings-to-date and not much of a business plan. Investing in nothing but a dream is what created that bubble.

A new bust on the NADAQ – or any other major international index – does not look likely any time soon because standard capital raising conditions have again become the norm – but markets often go sideways for a while after a significant new high is reached. The end???of???month sell???off on the NASDAQ is of no great concern. It’s called profit taking.

The S&P 500 – and other major markets around the world also reached new all-time highs in April. The recent earnings season in the US was quite good but the consensus seems to be that the next strong rally might not kick off until the second half of 2015. We see around 7% growth in the S&P 500 from the end of April to New Year’s Eve.

Bonds

It is never clear where the discussions between Greece and the banking authorities stand. But, as the Greece economy is only about 2% of the Eurozone economy, we do not expect any major fall-out to markets that affect us, no matter how the Greece situation ends – within reason of course. The very latest talks revealed that the Greece government is giving some ground.

Our 10-year bond yield stands at about 2.6% while the equivalent yield in the US is about 2.0%. But David Murray – former CEO of CBA and Chairman of the Future Fund – and Chairman of the recent Banking Inquiry, has just suggested that Australia could lose its AAA rating if it doesn’t manage its debt problems better. Goldman Sachs joined the chorus. Losing our AAA status would affect our yields and, importantly, have a detrimental impact on our big banks.

Interest Rates

The RBA did not cut rates in April. The inflation read of 2.3% pa released since that meeting, and the flat or improving labour market situation, are taking some of the pressure off the RBA to cut in May.

However, our economy continues to grow at below trend pace and it is very unusual for the RBA to only cut once. Changes in rates usually come at least in pairs, if not longer strings.

The government’s budget comes out after the next RBA meeting so there is a reasonable chance that the RBA will wait to interpret the possible impact of the new budget before it cuts again!

The US Fed has been in no rush to raise rates. We reiterate from last month that the current Fed rate range of 0% to 0.25% is not very different from 0.25% to 0.50% following one little hike, but markets would react negatively in the short run. The Fed’s minutes released in early April showed a split decision for a June cut and the labour market data released on Good Friday was so poor in comparison to the trend, that a June hike was almost ruled out of contention.

The Fed met again at the end of April and released yet another report. This time they removed any mention of a calendar date for a rate hike – supporting the pushing out of expectations for a hike. However, they do see the weak economic growth in the US at the start of 2015 as transitory with a pick up expected in the second half of 2015.

Other Assets

It does not follow that the recent rebound in oil and iron ore prices means that this is sustainable or prices will continue to rise. However, the particularly gloomy forecasters of a month or so ago seemed to have gone into hiding.

We believe it is unwise to simply extrapolate the April rally into rising commodity pricing but that does not stop us from being positioned to take some additional benefits from any further rally – should prices happen to rise further.

Regional Analysis

Australia

It was only one of many surveys in April but the weekly ANZ-Roy Morgan ‘economic outlook’ poll at the end of April jumped by +8.6% in a week to a creditable index value of 111.8. Of course it might turn out to be a statistical aberration but we cannot rule out that the government’s softening stance in budgetary measures is starting to boost optimism.

ANZ’s weekly consumer confidence index in the same survey release was below its average. Outlook and confidence measures are misaligned at the moment and variable. Could it be that confidence lags economic outlook, outlook ticked at the very end of the quarter? But Retail Sales were up +0.7% for the month! Another indicator of a late change in views after the budget stance increasingly softened.

Some interpreted the fall in our unemployment rate from 6.3% to 6.1% in the April release (for March) as a great sign of recovery. Equally the increase in jobs of +37,700 was particularly well received. But we agree with the Australian Bureau of Statistics (ABS) – and our past, frequent comments in these economic updates – which we should focus on the ABS published trend data rather than the volatile seasonally-adjusted headline data. The trend data have been flat for months. It is far too early to get excited and, equally, gloom should be set aside.

The inflation data came out and they may have looked a bit confusing to non-professionals. The RBA focuses on a measure that strips out the impact of certain volatile items such as oil prices. The ‘headline’ number was a low +1.3% but the RBA-preferred measure was +2.3% which is close to the middle of the RBA’s target range of 2% – 3%. So inflation is not currently a problem.

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in at 50.1 – the same as in the previous month. A number above 50 signals growing economic growth.

The new China economic growth figure came in at 7% in April, bang on the new target figure for the year. Some analysts were negative about this number because it was the lowest in 9 years.

It is well-known (or at least should be) that most companies and countries that start from a low base go through a period of rapidly growing growth rates to be followed, as the company or country starts to mature, by slowing growth rates to values like the current 3% economic growth (on average) rate experienced in the US, UK and Australian economies.

In terms of the ‘volumes of goods and services’ now being produced in China, 7% growth now is much, much bigger than 7% a decade ago because the China economy has more than doubled in size. One day, when the China economy has fully matured, it will probably grow at around 3% like other developed economies. Do we worry that the US and Australia only grows at around 3% pa on average? No!

U.S.A.

The US had a particularly poor nonfarm payrolls (jobs increase) figure at the start of April when it came in at +126,000 for March – or about half of an average month over 2014. But the unemployment rate remained steady at 5.5%.

Possibly, the particularly cold winter again temporarily impacted on jobs growth in March – or was it another statistical aberration? It was, however, encouraging that the hourly average wages figure ticked up by a moderate +0.3% from +0.1% the month before. The Fed focuses on wages growth because that is a better indicator of labour market pressure than just numbers of people in work.

US GDP growth in quarter one was a miserable +0.2% (annualised) after the +2.2% in the last quarter of 2014. Economists had expected a slowing – but only to +1.0%. The Federal Reserve stated that it believes this low result is transitory and strong growth will resume in the near future.

Europe

Consumer price inflation was only up +0.1% in Europe. Economic growth in the UK was up +0.3% for the quarter. Of course fears of Greece debt problems are muddying the waters.

Rest of World

Japan had its debt downgraded to A from A+ by the Fitch rating agency and that follows a recent downgrade by Moody’s. It seems that Japan and the world shrugged that downgrade off.

^{*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.}