The Big Picture

Last month we tried to leave you with the view that the stock market machinations were not really connected to any particular market view of economic fundamentals. A month later and markets moved even lower before they started to recover towards the end of February.

Iron ore prices rose to over $51 / tonne from $38 in December. Oil prices are well above the lows of January/February. And while no one is suggesting commodity markets are heading higher and higher, the panic attack at the start of the year seems to be well behind us.

But then we got a new spruiker in town during February predicting a 50% fall in property prices in Australia! We won’t name them because you have probably never heard of them and almost certainly won’t again. Every few years we get such attention seekers. Presumably they are selling (or short selling?) something. We think they have no credibility in the profession.

But just for fun let’s assume prices fell by 50% as ‘predicted’. That would take prices back to GFC levels when a different spruiker was then predicting a 40% fall. And so it goes on.

Prices only fall significantly when people are forced to sell at a loss. Australians by and large have jobs and seem unlikely to lose them. Many have big offset accounts for their mortgages and others are simply well ahead on payments. Of course individual properties or pockets of properties may lose value for a variety of reasons – but not the average.

What is fascinating at home is the recent mooted change to Senate election process. You may recall we argued after the last election something had to change in this regard to provide for a stable government with a strong economy. Well it looks like voters will now have to state whom their preferences are to be distributed rather than the old under-the-table deals by the parties that produced the motley crew of senators we got last time.

Turnbull seems to have swept everything off the table that was recently on it – including a possible hike in the GST. A good conspiracy theory we could start is that the likely double dissolution on July 2nd was always the main game. The government may have ‘sucked in’ the opposition to announce alarmist policies on negative gearing and tax increases – to give the government greater ammunition to sweep into power in both houses. And then new tax policies could be launched in the next term. Makes far more sense than a 50% fall in house prices!

Our economy is still doing quite well but with a functioning government (of either party) devoid of irritations from senators most didn’t know they were voting for 2017 and beyond, which could be really, really good.

But wait. There’s more! The US elections are heating up. It looks like Trump versus Clinton in the November presidential elections. Clinton frightens Wall Street because of her views on healthcare and Trump has stated he will tax Wall Street! One report that doesn’t seem to have attracted enough attention is that Michael Bloomberg – the former New York mayor– said he would run for president if “circumstances warranted it”.

If Trump gets the Republican nomination, might Bloomberg run and win? That sounds like a preferable scenario for markets, the US and us.

And in the rest of the world? The G-20 meetings in Shanghai last weekend didn’t produce a statement of any substance – but they did decide not to organise a co-ordinated global stimulus package. That’s good news. We just don’t need such a package!

Asset Classes

Australian Equities

As we said at the time, the ASX 200 was very oversold earlier in 2016. Most companies reported earnings during February and, by large, they were quite strong. Of course Slater & Gordon, BHP and some others are not in that group but there was a sizeable number of share prices that jumped 5% – 10% and more on the news of their earnings’ results. Investors had been pricing in the worst and so dived back in to buy when those fears became unfounded.

In spite of recent rallies we still have the market well under-priced. We have fair value at 5,300 and an end-of-2016 well on its way towards 6,000. The February close was 4,881.

Interestingly, there were several trading days in late February when we had a good ‘lead’ from Wall Street and/or started the day well only for the market to fizzle near the end. Trading volumes have been strong so investors in Australia aren’t yet buying the international story.

The banks have been heavily sold off. Some argue this is in part due to Sovereign Wealth Funds (Norway, Saudi Arabia and elsewhere) selling off equities to generate cash to keep government budgets under control while oil prices are depressed.

Also, the issuance of bank ‘Hybrids’ with attractive coupons may have added to the sell-off. With expected share yields at 6.7% plus franking credits, some of the big banks’ shares could look very attractive for investors wanting yield. While equity yields are far from guaranteed, it does not seem likely that further capital raisings to satisfy the regulators (as during last year) will be needed this year – and future capital requirements will likely be introduced more slowly than in last year.

Foreign Equities

Markets around the world were quite volatile but the VIX ‘Fear Index’ did not reach the highs of last year – nor during the European crises and GFC. In short, the VIX measures market activity in taking out insurance against future market falls – called put options. The market is not fearful and the current VIX read is not much above average levels as of the end of February!

But our market lost ???2.5% in February while the S&P 500 lost only ???0.4%. London lost only ???0.2% but Germany was down ???3.1%.

Bonds and Interest Rates

The prospect of Central Bank negative interest rates in a number of major countries did frighten the market as no one really knows what the full implications could be. But the US Fed considering negative rates was just that. Prudent regulation requires them to consider their options but their economy is far too strong for that to actually happen.

At home, it is quite possible that the RBA will cut rates once or twice this year. It is not that our economy is struggling that much but with five countries/regions having negative rates – and others having very low rates – the question has to be asked what benefit we get from holding at 2%.

Other Assets

Iron ore and oil prices have risen well above their recent lows. And while a big rally in either is unlikely it is reasonable to predict some further modest increases from here.

There have been some casualties from the recent price volatility. Saudi Arabia had its credit rating cut from A+ to A-; Exxon Mobil had its rating cut for the first time since the Great Depression; Royal Dutch Shell let 10,000 workers go; and BHP had to end its dividend policy with a sharp cut in dividends. This shake out should help support oil prices.

Regional Analysis

Australia

The last jobs data release was another in a long line of solid results but some commentators again missed the point in their quest to generate ‘news’. Trend unemployment remains under 6.0% (having fallen from 5.9% to 5.8% over the last month) and wages growth was reasonable.

But our ‘CAPEX’ (Capital Expectations) data on investment decisions and intentions were weak. Some analysts who were predicting the Reserve Bank of Australia (RBA) would be on hold this year have now moved to the one or two rate-cuts camp.

Consumer and Business Confidence data have softened a little – suggesting the Turnbull honeymoon is over. However, as clarity about the election, tax policy and the budget emerges confidence could be quickly restored.

China

China’s currency received a lot of attention from markets but our RBA Governor stated that he was surprised at the reaction because it was what he expected.

The manufacturing side of China remains softer than the services side as the government wants. It did place $US25bn into the financial system to keep liquidity at reasonable levels. It also cut the Reserve Requirements Ratio for banks for the fifth time in a year by 0.5% to 17%.

U.S.A

The US ended February with unexpectedly strong data on growth and inflation. Importantly, the Federal Reserve formally stated that it believes full employment corresponds to 4.9% and that was the outcome for January – and with solid employment growth. So with employment strong and inflation returning, that’s just what the Dr (Yellen) ordered!

As a result, the market has increased the chance of a rate hike this year from close to zero up to nearly 40% for a June hike. However, there is no rush so March seems off the table.

Of course new data are being released on a frequent basis and views will evolve. But just remember it was only a few weeks ago some commentators were calling for a rate cut in the US – even possibly to negative levels! That is why investors – rather than traders, spruikers and media commentators – need to watch calmly from a distance. Investors seek to increase wealth over the long run. The others make their ‘fortunes’ often during the day! Jumping at shadows can destroy an investor’s wealth.

So what happened to all of the commentators a few weeks ago predicting a US recession sometime soon? We think they’ve all gone into hiding!

Europe

German economic growth surprised on the upside and the UK retail sales surged +2.2% for the month – more than three times the expected rate. But EU inflation did fall back just into negative territory.

The ‘Brexit’ (Britain’s possible exit from the European Union) discussions were very prominent. David Cameron, the UK PM, seemingly came away with what he wanted.

Britain is desperate to change the freedom of labour movement rules – especially in the light of the recent migration problems that drain its social service benefits. It also wants to keep its own currency – rather than join the euro – indefinitely. A referendum on Brexit is slated for June 23rd.

Cameron is coming under fire from within his own divided party. He has said that he won’t stand for re-election and the ‘hot money’ is now on Boris Johnson (now being referred to in some quarters as ‘BoJo’) – the eccentric Tory MP and Lord Mayor of London – to be the next British PM.

Rest of the World

Japan’s economic growth came in even worse than expected at ???1.4%. North Korea ‘tested’ a ‘satellite launcher’ which was interpreted by everyone else as a test for a ballistic missile. Not to be outdone, China launched a surface-to-air missile in the disputed man-made islands in the South China Seas.

Saudi Arabia, Russia, Qatar and Venezuela got together to talk oil supply. They agreed to keep production at January levels but Iran immediately complained because it is only just getting back on stream after a lengthy ban from sanctions over its nuclear programme. Of course putting supply on hold does not necessarily lift prices – but it might stabilise them. A cut in supply seems unlikely anytime soon.

*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.