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Economic Update - May 4th, 2016

Economic Update – May 2016

by Infocus

The Big Picture

April witnessed further strong gains on share markets. These gains were helped by commodity prices rallying hard. Iron ore prices rose around +20% in April making the gain from December’s $38 to April’s $70 peak impressive indeed. Brent Oil gained about +24% in April!

So why did these commodity prices gain so much? Well, China restocked its steel inventories causing a 50% plus gain in China steel prices this year. Some of this restocking was due to more stimulus spending by the Chinese government but some was just a natural part of the cycle.

Saudi Arabia seemingly failed in the Doha talks to get an OPEC/Russia deal to stabilise prices. But Saudi Arabia then went on to make a massive policy statement on Anzac Day to create a new economy that is far less dependent on oil revenue. This latter action has seemingly supported oil prices.

At home there was some slightly worrying economic news. Inflation for the March quarter came in at ???0.2% when +0.2% was expected. The annual figure was +1.3% against the expected +1.7%. Since the Reserve Bank’s (RBA) target range is +2% to +3% ‘over the cycle’ we are not yet in trouble but an interest rate cut is now far more likely.

The Labour Force survey showed that the unemployment rate fell to 5.7% but the underlying trend data did not improve. Indeed, the trend employment data disappointed for the first time in more than a year. Full-time employment is now growing at 0%! A second reason for a cut! Indeed, the market is now factoring in an imminent cut at home despite the political implications.

China data came in strongly over the month. Exports were up +18.7% over the year; GDP came in at +6.7% and both Retail Sales and Industrial Output beat expectations. The China manufacturing Purchasing Managers’ Index (PMI) just came in above the all-important 50 at 50.1.

There is so much news set to drop over this and the coming week or two that we will be a lot wiser in a couple of weeks. Our Budget and its associated forecasts have revealed a number of changes in addition to the RBA which reduced rates by 25 basis points to 1.75%. The all-important US jobs data are due on Friday May 6th.

And we should not underestimate the possible ramifications of a June 23rd ‘Brexit’ referendum to decide Britain’s future role in Europe. And throw in an election for us on July 2nd.

The US Federal Reserve meeting at the end of April did not announce a rate hike as expected despite Chair Yellen repeatedly saying it was a ‘live’ meeting. Importantly Yellen removed the previous comment about global risks but added that the US economy was showing some signs of a slowdown. Indeed, the latest economic growth figure released after the meeting for quarter one was a very disappointing +0.5% (annualised).

April’s release of the March jobs data showed a solid but modest increase of 215,000 new jobs with a slight increase in the unemployment rate to 5.0%.

So in conclusion, there is a little extra economic uncertainty around at the moment but, when the dust settles, we are looking at steadily but not strongly growing markets and economies.

Asset Classes

Australian Equities

The ASX 200 had a splendid month gaining +3.3% on the back of +4.1% in March. That still leaves it down ???0.8% on the year-to-date but up +0.5% if we include reinvested dividends.

The Materials sector gained a massive +14.2% in April on the back of surging iron ore prices – now up 50.0% for the year-to-date. Energy wasn’t far behind at +7.6% for April as oil prices too have been very strong. Brent Oil is up + 32.1% year-to-date. The big problem has been the big banks. Not only have they continued to collect criticism over their behaviour, there is widespread speculation that dividend policy will change. The Finance sector was up only +1.4% for April.

We are expecting a bout of volatility with the coming Budget and interest rate decisions here and overseas but that volatility could take us up rather than down!

Foreign Equities

The S&P 500 only gained +0.3% in April but they had a stellar March at +6.6%. The index has been flirting with all-time highs making some investors nervous – until they break through it!

The VIX ‘fear’ index has drifted back to average levels after a period at well-below average levels.

Bonds and Interest Rates

The Bank of Ireland issued a 100 year bond at 2.35%. That means there are sufficient people prepared to lock in a low rate of inflation for 100 years as the fixed rate of return needs to be above inflation to compensate investors for risk. Strange times indeed!

The RBA unsurprisingly kept its rate on hold again in April but there was increasing support for an imminent cut after the latest inflation read. The RBA delivered that cut on the 3rd May and the market then rallied hard.

The US Fed did not hike its rate in April and analysts are divided between no hikes and up to two hikes this year. We do not see an imminent hike but one is possible around December or early next year. June is possible but the proximity of the November elections and the weakening US economy should keep the Fed on hold.

The oil giant ExxonMobil lost its AAA credit rating from S&P for the first time since the Great Depression. Naturally, a number of smaller oil companies are facing stressed credit views.

Other Assets

Iron ore prices were up +20% over the month after the previous month’s +10%. The price has already fallen about $6 / tonne from the April peak of over $70.

Oil prices too have continued growth and Brent Oil was up about +24% on the month.

The price of gold was up +5% but both UBS and Macquarie suggest that peak gold prices for 2016 have already been made.

Regional Analysis

Australia

Turnbull seems to have lost his ascendency in politics but the Budget might change that. Consumer confidence has waned and someone has to take the reins. The Budget is critical.

Amazingly, the soft Labour Force data went largely unnoticed but the inflation data did grab attention. We don’t know how much steel will be used in building the new Franco-Australian submarines but surely it can’t support an entire industry.

The headline unemployment rate was fine at 5.7% but remember that was just about the peak in the GFC!!! Inflation is in the doldrums and the last economic growth figures were nothing to write home about. We are far from bad but good seems so far away. We need a government in control.

China

China started the month with a target range of 6.5% – 7.0% for economic growth rather than a single figure such as the previous target of 7.0%. Well, they nailed it at 6.7% and a plethora of other good statistics. Some analysts still complained.

So if, as we firmly believe, the so-called hard landing has been well and truly avoided, what next? Less volatility on China data? More optimism on world growth? We can’t be sure but the worst seems to be well behind us and most now agree.

U.S.A

The US is becoming a scary place as the Presidential election approaches. Trump with his Mexican Wall and Muslim bans is one thing (not nice) but Clinton is now wagging fingers at China over trade policies.

China, like the US, Australia, Europe etc., might occasionally do the wrong thing but nobody normally wags a finger in high office – they use diplomacy. The US will not come out of 2016 well. It seems like the US is on a slippery slope.

Donald Trump, the US Presidential hopeful predicted a ‘massive recession’ for the US this year. Dr Bernanke, the former US Fed Chair and of this world, said in a special meeting with the last four Fed Chairs that a recession has a small chance of occurring in any year and 2016 was no more likely than 2015 or 2014. We are in the same camp as these exalted and eminently qualified public servants.

The latest growth data were a little low but most are expecting a rebound in the second quarter. Jobs data continues to be strong.

Europe

Europe is on the brink of a major rethink as the UK holds its referendum on whether or not it should stay in the European Union. President Obama ‘happened’ to turn up in London to meet the Queen and the Prime Minister. That’s all fine but is he now a lobbyist for the ‘stay in Europe’ vote?

The immigration problem seems to have stabilised – to some extent – but much of the Brexit problems are over the free movement of people into the UK to take up public housing and benefits with no qualification period. They seemingly believe real refugees should be happy to be settled in France (where numerous UK people go for nice holidays) rather than try to enter Britain illegally on the back of a truck from Calais. Cameron did win many concessions on points such as this so the call could be close.

Nobody can reasonably predict what will actually happen if the UK leaves the Union. But there are reports that three EU countries might consider their options if Britain does exit the EU.

Rest of the World

North Korea continues to flex its missile muscles. Iran refused to go to the Doha OPEC meeting on April 17th to discuss supply controls.

Japan had strongly been hinting at providing more stimulus but then disappointed markets at the end of the month by holding firm.

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