Economic Update – May 2015

The Big Picture

The ASX 200 spent April toying with the idea of breaking through 6,000 – and breaking through is oh so different from staying above 6,000! We have now had five surges before retreating back to just under the elusive 6,000 figure and this has occurred within the last two months. But that isn’t a problem – it is normal market behaviour. We have the market priced at around 5,850 so we will likely get to 6,000 one day soon – and stay there come the second half of the year.

After iron ore and oil prices tumbled over 2014, there have been impressive bounce backs in both of these commodity prices. We have argued previously in this update that both prices were being manipulated by the big three miners for iron ore and OPEC for oil.

While the doomsayers were predicting the end of the world, iron ore prices surged from around $US47 per tonne mid-April to above $60 before a small end-of-month sell off. Brent oil (the world price) started April at $US54 per barrel and reached as high as $66.76 at the end of the month.

Naturally, these commodity price movements helped stocks in the resources sector of the ASX 200 but some high yield stocks came off a bit in price as some investors rebalanced their portfolios.

The big fall at the end of April (just after the fifth bounce below 6,000) of ???109 points in one day – only to be followed by a fall of ???49 points on the next/last day – certainly brought some investors to their senses. We would rather the market frequently have these ‘baby’ corrections rather than having blasted through 6,000 only to fall back to 5,000 because of a bursting bubble. After the big fall that occurred on the 29th April, the market finished 12 points below our previously-held estimate of fair value of 5,850 – just 60 points above where the index finished in April.

The Reserve Bank of Australia (RBA) kept rates on hold against the odds after its early April meeting. The market had priced in a 75% chance for the RBA to cut its rate by 0.25%. Naturally, the market immediately priced in the next cut for the May 5th meeting with equal gusto – but the change in direction for commodity prices in subsequent weeks have dampened expectations for a cut in the immediate future.

But most analysts seem to be calling for at least one more cut this year from the current 2.25%. However, 2% is seen as a psychological barrier for many making only one cut slightly more likely than two.

The Governor of the RBA, Glenn Stevens, gave a speech at the end of April pointing out that monetary policy – such as varying interest rates – has done just about all of the work it can for the economy. It now needs the government to create a particularly good budget in terms of creating confidence and growth.

The Governor also pointed out that retirees are worse off than those from a decade ago in terms of finding almost risk-free yields from which to generate a stable income (but many do have 10 extra years’ worth of compulsory super savings to help out!) . And he emphasised that this situation is likely to last for a long time. The importance of investors – in this low rate regime – discussing investment strategies with their advisors is becoming increasingly important. But we are not alone. Low rates are a global phenomenon.

Foreign Equities

It took 15 years, but the NASDAQ (the US ‘tech’ index) at last reached a new all-time high. Of course the dot-com boom and bust of 15 years ago was fuelled by some companies listing for the first time (known as IPOs) on the stock exchange with no earnings-to-date and not much of a business plan. Investing in nothing but a dream is what created that bubble.

A new bust on the NADAQ – or any other major international index – does not look likely any time soon because standard capital raising conditions have again become the norm – but markets often go sideways for a while after a significant new high is reached. The end???of???month sell???off on the NASDAQ is of no great concern. It’s called profit taking.

The S&P 500 – and other major markets around the world also reached new all-time highs in April. The recent earnings season in the US was quite good but the consensus seems to be that the next strong rally might not kick off until the second half of 2015. We see around 7% growth in the S&P 500 from the end of April to New Year’s Eve.

Bonds

It is never clear where the discussions between Greece and the banking authorities stand. But, as the Greece economy is only about 2% of the Eurozone economy, we do not expect any major fall-out to markets that affect us, no matter how the Greece situation ends – within reason of course. The very latest talks revealed that the Greece government is giving some ground.

Our 10-year bond yield stands at about 2.6% while the equivalent yield in the US is about 2.0%. But David Murray – former CEO of CBA and Chairman of the Future Fund – and Chairman of the recent Banking Inquiry, has just suggested that Australia could lose its AAA rating if it doesn’t manage its debt problems better. Goldman Sachs joined the chorus. Losing our AAA status would affect our yields and, importantly, have a detrimental impact on our big banks.

Interest Rates

The RBA did not cut rates in April. The inflation read of 2.3% pa released since that meeting, and the flat or improving labour market situation, are taking some of the pressure off the RBA to cut in May.

However, our economy continues to grow at below trend pace and it is very unusual for the RBA to only cut once. Changes in rates usually come at least in pairs, if not longer strings.

The government’s budget comes out after the next RBA meeting so there is a reasonable chance that the RBA will wait to interpret the possible impact of the new budget before it cuts again!

The US Fed has been in no rush to raise rates. We reiterate from last month that the current Fed rate range of 0% to 0.25% is not very different from 0.25% to 0.50% following one little hike, but markets would react negatively in the short run. The Fed’s minutes released in early April showed a split decision for a June cut and the labour market data released on Good Friday was so poor in comparison to the trend, that a June hike was almost ruled out of contention.

The Fed met again at the end of April and released yet another report. This time they removed any mention of a calendar date for a rate hike – supporting the pushing out of expectations for a hike. However, they do see the weak economic growth in the US at the start of 2015 as transitory with a pick up expected in the second half of 2015.

Other Assets

It does not follow that the recent rebound in oil and iron ore prices means that this is sustainable or prices will continue to rise. However, the particularly gloomy forecasters of a month or so ago seemed to have gone into hiding.

We believe it is unwise to simply extrapolate the April rally into rising commodity pricing but that does not stop us from being positioned to take some additional benefits from any further rally – should prices happen to rise further.

Regional Analysis

Australia

It was only one of many surveys in April but the weekly ANZ-Roy Morgan ‘economic outlook’ poll at the end of April jumped by +8.6% in a week to a creditable index value of 111.8. Of course it might turn out to be a statistical aberration but we cannot rule out that the government’s softening stance in budgetary measures is starting to boost optimism.

ANZ’s weekly consumer confidence index in the same survey release was below its average. Outlook and confidence measures are misaligned at the moment and variable. Could it be that confidence lags economic outlook, outlook ticked at the very end of the quarter? But Retail Sales were up +0.7% for the month! Another indicator of a late change in views after the budget stance increasingly softened.

Some interpreted the fall in our unemployment rate from 6.3% to 6.1% in the April release (for March) as a great sign of recovery. Equally the increase in jobs of +37,700 was particularly well received. But we agree with the Australian Bureau of Statistics (ABS) – and our past, frequent comments in these economic updates – which we should focus on the ABS published trend data rather than the volatile seasonally-adjusted headline data. The trend data have been flat for months. It is far too early to get excited and, equally, gloom should be set aside.

The inflation data came out and they may have looked a bit confusing to non-professionals. The RBA focuses on a measure that strips out the impact of certain volatile items such as oil prices. The ‘headline’ number was a low +1.3% but the RBA-preferred measure was +2.3% which is close to the middle of the RBA’s target range of 2% – 3%. So inflation is not currently a problem.

China

China’s Purchasing Managers’ Index (PMI) for manufacturing came in at 50.1 – the same as in the previous month. A number above 50 signals growing economic growth.

The new China economic growth figure came in at 7% in April, bang on the new target figure for the year. Some analysts were negative about this number because it was the lowest in 9 years.

It is well-known (or at least should be) that most companies and countries that start from a low base go through a period of rapidly growing growth rates to be followed, as the company or country starts to mature, by slowing growth rates to values like the current 3% economic growth (on average) rate experienced in the US, UK and Australian economies.

In terms of the ‘volumes of goods and services’ now being produced in China, 7% growth now is much, much bigger than 7% a decade ago because the China economy has more than doubled in size. One day, when the China economy has fully matured, it will probably grow at around 3% like other developed economies. Do we worry that the US and Australia only grows at around 3% pa on average? No!

U.S.A.

The US had a particularly poor nonfarm payrolls (jobs increase) figure at the start of April when it came in at +126,000 for March – or about half of an average month over 2014. But the unemployment rate remained steady at 5.5%.

Possibly, the particularly cold winter again temporarily impacted on jobs growth in March – or was it another statistical aberration? It was, however, encouraging that the hourly average wages figure ticked up by a moderate +0.3% from +0.1% the month before. The Fed focuses on wages growth because that is a better indicator of labour market pressure than just numbers of people in work.

US GDP growth in quarter one was a miserable +0.2% (annualised) after the +2.2% in the last quarter of 2014. Economists had expected a slowing – but only to +1.0%. The Federal Reserve stated that it believes this low result is transitory and strong growth will resume in the near future.

Europe

Consumer price inflation was only up +0.1% in Europe. Economic growth in the UK was up +0.3% for the quarter. Of course fears of Greece debt problems are muddying the waters.

Rest of World

Japan had its debt downgraded to A from A+ by the Fitch rating agency and that follows a recent downgrade by Moody’s. It seems that Japan and the world shrugged that downgrade off.

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

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