Economic Update – April 2018

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

Geopolitical Stability emerges

– National leaders re-elected

– Russia-OPEC deal

– Economic data strong

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

March was not a good month for global equity markets but there were many signs of an emerging global stability.The Big Picture

Russia’s Putin and Germany’s Merkel each got elected to a fourth term in office. China’s Xi also was re-elected after China allowed for more than two terms at the helm. Having stability at the top is more likely to lead to more of the same – and that’s good for expected global growth.

The US Federal Reserve increased its benchmark interest rate by 0.25% but did not change its expectations of three hikes this year, to the four expected by a big chunk of the market.

The Bank of England flagged a rate increase in May but the Reserve Bank of Australia (RBA) continues to remain on hold. The European Central Bank (ECB) removed its ‘easing bias’ from its communications. Again – more of what was expected.

Towards the end of March, Russia and OPEC announced negotiations for a new deal on controlling supply and, hence, price. They are moving toward replacing the current annual plan to one of lasting a decade or more. Of course the member states would have to adhere to the plan but these signs are also encouraging.

The fly in the ointment for March was Trump’s trade tariffs with possible repercussions in the form of a trade war. Trump started loud and strong but, as March progressed, he softened his stance with a view to negotiating a reasonable solution.

While the various incarnations of the tariff policy were bandied around, markets took sizeable hits. Wall Street had a few days of around 2% changes.

The net result was that the World share index was down ?2.5% for March and ?1.8% for the year-to-date. Our ASX 200 index was down ?4.3% in March but we did not benefit from the strong rally in the US after our market closed.

Facebook suffered major losses for unrelated reasons. It transpires that there have been major breaches of security for personal information. Since Facebook’s market capitalisation is so large, the broader indexes were materially affected by these share-price drops.

On the economic front, US inflation came in bang on expectations and just under the target rate. The wobbles caused by a stronger wage inflation number earlier in the year have dissipated. US GDP growth was revised upwards for the fourth quarter of 2017. The initial read released in January was 2.5% but March’s revision was up to 2.9% when only 2.7% was expected.

China’s Purchasing Manager Index (PMI) readings bounced back after the pollution-reduction measures ended for the year.

At home our retail sales figures disappointed at 0.1% for the month but these data are quite volatile. GDP growth came in at 2.4% for the year against an expectation of 2.5%.

The jobs data were quite strong with over 60,000 new full-time jobs reported. Unfortunately, there was a sharp fall in part-time jobs leaving a more modest number of total new jobs created.

The unemployment rate did kick up one notch to 5.6% but the trend unemployment rate remained static at 5.5%.

We interpret all of this new information reported over March as supporting equity markets having a strong year over 2018. We see the wobbles of February and March as being controlled variations as are normal in equity markets and not the start of something sinister.

In spite of the events largely occurring in the US, the VIX ‘fear’ index was quite well-behaved and is now back to a level that is only a little over the average.

Asset Classes

Australian Equities

Our ASX 200 lost ?4.3% over March but Financials and Telcos each lost more than ?6%. Materials, including the likes of BHP, lost ?5.6%. No sector produced a positive return but Property was flat for the month.

We believe that the market is quite cheap at this point (about 4% under-priced) and trend expectations for gains are quite strong (about 7% pa). As in many cases, February-March was a period for holding tight rather one of than trying to trade the market.

The forecast yield for the index is around 4.8% plus franking credits. Shorten’s call for clawing back some franking credits may have contributed to the exit from the traditional homes of fully franked dividends: Financials and Telcos.

Foreign Equities

The S&P 500 index had a very strong final day for the month so it only finished down by ?2.7%. The major markets performed similarly. Markets – including emerging markets – behaved in this fashion, suggests that this was a broad-based sell-off. There have been no strong indications of which industries would be most affected if, indeed, a trade was to build momentum.

Bonds and Interest Rates

The RBA did not change rates at the March meeting. It is doubtful that they will raise rates in 2018 and they might even cut.

The US Fed raised rates by 0.25% at its March meeting. They did not take the opportunity to increase the number of forecast hikes for 2018 but an extra one has now been pencilled in for 2019/2020. The new chair, Jay Powell, comes across as being a strong leader, who is prepared to speak more openly than past chairs. Powell seems confident that the US economic growth will stay at these levels or even improve in coming quarters.

At last the ECB has removed its ‘easing bias’ comment from its statements. It is still a long way from tightening monetary policy. Thankfully, it is also a long way away from the financial crises that faced the European Union shortly after the GFC.

Other Assets

After a strong February, the price of iron ore had a major correction of ?20% in March. The price of oil gained strongly in March with Brent oil (the international benchmark) touching $70 / barrel. Our dollar slipped to $US 0.7665. It was nearly 81 cents earlier in 2018.

Regional Analysis

Australia

In a trend sense, about 19,000 new jobs were created in February (and reported in March). The more volatile seasonally adjusted number was just a fraction lower but the full-time / part-time changes were stark.

There were approximately 65,000 new full-time jobs in February but a loss of ?46,000 part-time jobs. Closer examination reveals that this imbalance over new jobs by hours worked is simply a reversal of the previous month’s job creation pattern. In short, jobs are being created in a trend sense but not enough to bring down the unemployment rate from a trend level of 5.5%.

Economic growth for the final quarter of 2017 missed expectations at 0.4% which translated into 2.4% for the year. Growth is travelling at just short of trend.

China

Unsurprisingly, President Xi was elected to another term in office now that restrictions on re-election have been removed. There is a new governor for the People’s Bank of China (PBOC) in Yi Gang.

China is at last flexing its muscles over North Korea’s nuclear programme. It has used trade sanctions to bring North Korea to the negotiating table.

China’s manufacturing PMI bounced back to 51.5 from February’s 50.3 reading; the services PMI climbed to 54.6 from 54.0 and the combined manufacturing/services PMI came in at 54.0. Since it is a reading of 50 that separates contraction from growth, these are indeed strong readings. Analysts are interpreting the rises since February are at least in part attributable to the relaxation of pollution-reduction measures taken over the winter months.

US

The US started March with a particularly strong jobs report. 313,000 new jobs were created and the unemployment rate was steady at 4.1%.

Fourth quarter GDP growth was revised up to 2.9% from an initial 2.6% and a revised 2.5% in February.

The US CPI data produced a headline figure of 2.2% and a ‘core’ rate of 1.8%. It is the latter that the Fed focuses on. Its target rate is 2%.

It appears that Trump is entertaining the notion of meeting the North Korean president with a view to curbing its nuclear programme.

Europe

Germany’s Merkel at last formed a successful coalition to start her fourth term in office. On the other hand Italy voted in a populist styled government.

The European economy is healing to the extent that the ECB is no longer favouring an easing bias – but it is still a long way from tightening monetary policy.

Rest of the World

It was reported that South Korea is to reduce the normal working week from 68 hours to 52 hours!

India introduced a 60% tariff on the importation of chick peas which reportedly upset Canadian farmers. The US is not the only country using tariffs to balance trade.

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