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Economic Update - July 1st, 2015

Economic Update – July 2015

by Infocus

The Big Picture

The NAB business confidence survey came in at the best since August 2014, and the previous month, the Westpac consumer confidence index was the best since February 2014. On top of that, the Household Savings ratio is at last coming down to more reasonable levels reinforcing the confidence story. Don’t worry – we are still saving well but not hoarding in fear as we were.

On top of that, the official trend unemployment rate series for Australia – the preferred official index – peaked at 6.17% in December 2014 and has gradually improved each month since – to sneak to just under 6.0% for May!

Our GDP growth came in at 0.9% for Q1, 2015 and the number of jobs created again easily beat forecasts. The Reserve Bank kept rates on hold and the government got the pensions bill through parliament with the support of the Greens – within hours of Labor stating it would oppose it. At last our economy is starting to get going again.

China cut its official interest rate for the fourth time since November 2014 and removed its import duty on luxury goods. The main measure of manufacturing activity – the Purchasing Manager Index (PMI) – remains above 50 which indicates a slight rate of expansion.

Japan threw in a big revision to Q1 GDP growth – up from 2.4% to 3.9% on an annual basis. The UK delivered growth in pay of 2.7% on the year and ???0.1% on inflation – so people’s wages are better off (before tax) by 2.8% on the year.

The US posted a big +1.2% increase for the month on Retail Sales but some other data were a bit mixed. The June date for the US Fed to hike rates for the first time since the GFC came and went with no action – that’s not what most expected last year.

Indeed Fed rate official forecasts for the end of 2016 and 2017 have fallen to 1.75% and 2.75%, respectively. In other words, when rates do start to rise they are expected to do so very slowly. Some commentators think the first hike will be in September – and some even expect two hikes this year. But as the Fed keeps reminding us, the data must be strong enough first. We maintain that we expect that the first hike is more likely to happen next year. But that’s not bad. Indeed, it would reflect prudent policy if the data turn out to be not strong enough.

Even Europe gets some plaudits. There was a release of some bumper PMIs for some European countries in late June. But of course there is Greece!

It is exhausting following the Greek crisis. They have a Finance Minister (who held a position in Marxist Economics in university) negotiating – or rather not negotiating – with the IMF and various European governments and policy centres.

Europe and Greece both want Greece to stay in Europe but the price of membership is that Greece must agree to get its house in order. Portugal, Ireland and Spain all started in a similar position in 2010 but those so-called ‘PIGS’ countries took their medicine and successfully exited the bailout program last year.

Without being too harsh, the conditions needed to get the next bailout required Greece to accept the sort of conditions that most of us in the Developed World – such as Australia – live in. Don’t avoid your taxes; lift the retirement age up to 65; pay GST in the Greek islands as well as the mainland, etc. And their top marginal tax rate is well less than ours! I suspect that whatever happens will have almost no long-run impact on our economy and markets.

Asset Classes

Australian Equities

The ASX 200 had a shocking month (down ???5.5%) and no sector was spared. Of course the sell-off at the end of June over the Greek situation exacerbated the situation but May and June together have taken us down from nearly 6,000 momentarily to under 5,400 – a 10% correction!

We see this dip as short-term volatility. The financial year starting today is likely to be really good. Our forecast for next June 30th is 6,200 – so that’s up 14% in 2015/16! On top of that we can expect about a 4.7% dividends plus franking credits.

The year 2014/15 that just finished was nearly flat at +1.2% but the returns including dividends were +5.7% which was a lot better than cash – and franking credits would take that return to about 7%.

And different sectors performed very differently over the financial year. Health was up +29.2% and Telecommunications was close by at +25.8% – both including dividends. At the other end of the spectrum, the Energy sector lost ???20.2% on the back of the falling oil prices.

Although we have the market very underpriced, high volatility might continue for a few months due to Greece and the US Fed deliberations.

Foreign Equities

Wall Street outperformed our market over June (???2.1% against our ???5.5%) but London’s FTSE (???6.6%) was even worse than the ASX 200.

While most markets have had big sell-offs in recent weeks, the S&P 500 is only ???3.2% off its all-time high.

Bonds

The bond markets are currently more volatile because of the Greek crisis and the talk from the US Fed about starting to make its first move in raising rates.

What is surprising is that the Fitch (a major rating agency like S&P or Moody’s) estimated one-year probability of default is only 1.02% for Western Europe. It started 2015 at 1.43% and reached as high as 4% during the GFC. Markets aren’t really that worried about Greece.

Interest Rates

Neither the Fed nor the Reserve Bank made any move on rates in June.  The Fed stressed that when it starts raising rates, it will be at a snail’s pace. Of course increasing the rate from 0% to 0.25% should have no impact on doing business but markets like to react to things that move – particularly when they are just coming out of hibernation!

There is no real consensus about whether we will get any more cuts at home this year, but any hike is a very long way off. There is a reasonable chance of another cut in a few months but it isn’t anything to bank on. A lot will depend on unemployment and inflation data over coming months.

Consumer and business confidence indexes are starting to look very good. Perhaps a rate cut would boost confidence even further. But nobody should be investing in a new business that critically depends upon one more cut. On the other hand, it will be interesting to see what the impact of the small business package from the May budget is.

Other Assets

Iron ore prices moved largely sideways in June but dipped below $60 / tonne for the first time in five weeks today.

Brent oil prices were relatively unchanged over the month, but they did dip a little at one point.

Perhaps surprisingly, the price of gold has been stable in the face the Greek crisis. It was actually down ???$US11 on the month.

Regional Analysis

Australia

The RBA did not change rates in June but we suspect there will be another cut in the next few months. Although we see our economy as being strong enough not to need a cut, many are still worried and one more cut wouldn’t cause significant damage.

On property prices, we repeat that we do not believe that there is a price bubble in Sydney – even though prices have shot up sharply in the last three years (about 40%). A bubble is only a bubble if prices might fall as a result of some event. That would require people to start selling houses at a loss – or at least a paper loss. That’s not going to happen in Sydney.

It is a well-established fact in the capital cities of Australia house prices usually go through short spurts of price growth followed by elongated periods of low or no growth. And Sydney house price inflation cannot be caused by low-interest rates because the same rates apply across the country. Except possibly for Melbourne, nobody is talking bubbles elsewhere. Of course, localised property markets can and have experienced extreme price volatility.

But as I highlighted in the ‘Big Picture’, it is easy to see Australia as a country with growth just below trend. I even more firmly believe that the published trend unemployment rate will not see 6.5% as Treasury predicted in the May Budget over this cycle. But the number the media focuses on – and the Australian Bureau of Statistics advises against using – jumps all over the place and I refuse to predict any rate based on a sample of only 29,000 households!

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in today at 50.2 for the second month in a row. A number above 50 signals growing economic growth.

Like Greece, the China story will not go away for a very long time. The media feeds on stories and if there is no big news around it needs to find some. India is currently growing a little faster than China’s 7% target. And with ‘small’ China cities having more than 10 million citizens, there has to be a story to be found.

The PBOC (People’s Bank of China) just cut its main interest rate by 0.25% and its reserve ratio (the amount banks hold against loans) by 0.5%. China also removed import taxes from luxury goods. China is managing its economic destiny very well indeed.

Any prudent government changes tax rules and interest rates to glide an economy to where it needs. Think of Australia and what we are discussing about budgets and rates at the moment. China is no different. They are not panicking with massive or even big tweaks to policy. These changes would also look normal in Australia in recent times.

Yes, the first big wave of investment in China has ended, but much of China is still rural and poor. There will be more bursts of investment cycles to follow – after China has digested the impact of this last wave.

U.S.A.

After a very poor jobs number for March (+85,000 new jobs) the April data were quite strong with +223,000 jobs created and a 5.4% unemployment rate. The May number released at the start of June came in at a bumper +280,000 but unemployment slipped one tick to 5.5%. Only 225,000 new jobs were expected.

But the Fed is not happy with these numbers. The new jobs are still predominantly lower paying ones. Such employees typically spend all of their income on basics. They need wages growth to spread the gains across the economy.

The ???0.7% Q1 GDP growth figure (due to bad weather) was revised up to ???0.2% (both annualised) but everyone expected that. The US is sadly lacking productivity gains like so many other countries.

Europe

Europe ex-Greece is starting to do well – and in some places very well. Think back to 2010 when it looked like the eurozone might break up! That problem has gone away. Think of the start of 2014 when some talked of a recession in Germany. That problem too has gone.

Many mid-month preliminary PMIs were strong across Europe. Even Spain – with its 20%+ unemployment posted a number in the mid-fifties. Unemployment typically lags behind business expectations.

The Europe statistics are starting to look pretty damn good – even if you don’t include the UK. The UK growth in the first quarter of 2015 was just revised up to 2.9% over the year. Real (adjusted for inflation) household income was up a massive +4.9% in the quarter, and interest rates increase’s there are starting to be talked about.

Since midnight on June 30 has passed and Greece did not make its payment to the IMF, the bailout programme has officially ended. The referendum on Sunday is apparently worded as requesting a vote on continuing the bailout package – which no longer exists. Do they have the time to print new ballot papers and ship them out to the islands?

Sadly there is now talk of humanitarian aid being needed for Greece. Drug companies are owed more than a billion dollar’s but they have said they will continue to send drugs to Greece for now.

Rest of World Europe

Just when we thought Greece was enough of a handful, Puerto Rico announced at the end of June it had no chance of repaying its $72 billion debt. No doubt the US – with its very close ties – will bail them out. After all, you wouldn’t notice an extra $72 billion added to the $4.5 trillion US government debt!

The Iran nuclear talks are important. Depending on how they go, oil prices could move strongly either way on supply issues. Flip a coin.

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

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.

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