Economic Update – December 2015

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

Foreign Equities

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

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

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

Bonds and Interest Rates

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

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

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

Other Assets

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

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

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

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

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

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

China

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

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

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

U.S.A.

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

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

Europe

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

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

Rest of the World 

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

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

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

** Australian Bureau of Statistics

Important information

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