The Big Picture

We were calling for a rate cut in the last update on two grounds – full-time jobs (f/t) growth had stalled and inflation was low. We don’t get another read on inflation for a couple of months but May’s jobs report showed that the last three months had experienced cuts to trend f/t employment. That is worrying. The question is, will the RBA’s cut in May be enough?

No one else seems to be talking about this stall in f/t jobs which makes it even more worrying. The argument seems to be that 5.7% unemployment is good enough, but what has been happening is that f/t jobs are being replaced by part-time jobs (p/t). Since the official data just adds the two types of employment together for total employment, they are missing the point. An average p/t job is about 10 hrs/week, while it is around 40 hrs/week for a f/t position. And that’s why some of our consumer data isn’t as good as we would like.

The last GDP growth number was out of the box but that was largely driven by net exports. The domestic economy is not as strong. So we think we need at least a couple more rate cuts and the sooner the better. But what about the impact of the Budget? We think it isn’t likely to do much for the health of the economy in the short term. The main changes seem to be cuts to some company taxes and changes to superannuation regulations.

Around the globe, countries are trying to get debt under control rather than implement expansionary and costly fiscal programmes. We are no different and so we are reliant on our RBA.

In the US, their Federal Reserve (Fed) has been dragging its feet on enacting its second rate hike since the GFC. It promised four for 2016 last December when it made its first hike but now they are only predicting two this year. Markets don’t believe them. The Fed keeps saying each meeting is “live”, meaning that rates could go up at any time, but their accompanying language doesn’t back that.

In a recent speech at Harvard, the Fed Chair, Janet Yellen, used words like ‘probably raise rates’, ‘in coming months’, and ‘if economic data improve’. Not exactly positive wording! US jobs data in May were a bit on the weak side and US GDP growth was revised up from +0.5% for the year to only +0.6% when trend growth is closer to 3.0%. These data do not seem strong enough to warrant a rate hike now and it may be many months or more before they are.

Data in China has been a little bit lighter than expected, but oil and iron ore prices seem to have stabilised after extreme volatility at the start of 2016.

Japan’s economy continues to struggle. It planned a staged increase in sales tax when Prime Minister Abe came to power a few years ago, but he has just postponed the second hike for a second time! Increases in taxation are contractionary and their economy, like ours, needs the opposite.

The UK is facing up to its referendum on whether to leave the European Union on June 23rd. The enigmatic Boris Johnson is leading the exit campaign while the PM is for staying in. Polling does suggest that Britain will remain in the EU. An exit would cause great market instability.

Asset Classes

Australian Equities

Gains were made on the ASX 200 for the third consecutive month. The gains of +2.4% in May were not evenly spread across sectors. Healthcare made particularly impressive gains of +9.4% with three other sectors posting very strong gains: Consumer Discretionary (+5.8%); IT (+6.5%); and Telecommunications (+5.0%).

Of course there have to be underperformers. Energy (???1.8%) and Materials (???3.3%) actually lost ground in May.

High yield sectors have lost ground in the year to date, but when dividends are included, they have just held their ground.

The prospects for earnings growth over future years have been growing to the extent that we still think the ASX 200 might finish the year around 5,850 from an end of May level of 5,379.

Market volatility is back to normal levels after a taxing first quarter. We have the index only slightly overpriced, with a current fundamental level of 5,300.

Foreign Equities

The S&P 500 also gained in May but by less than the ASX 200. The World index was almost flat at +0.2%.

The VIX index, which purportedly measures ‘fear’ on Wall Street, has reached quite low levels when compared to historical values. Markets are no longer feeling stretched.

We also see good gains in Wall Street over the rest of 2016 growing, at an annualised rate of over +15% pa.

Bonds and Interest Rates

The RBA cut our rate from 2.0% to 1.75% in May. There are strong calls for more cuts, this year from most quarters. Macquarie was the first to predict at least three cuts in the foreseeable future. Morgan Stanley joined that camp later in May. We see no advantage to Australia in not cutting at least twice – and soon.

The Fed keeps stating the rates may soon go up, but they never seem to do anything! And they would be silly if they hiked, and then had to reverse the policy anytime soon. We are of the opinion a hike is unlikely before December. However, the market seems prepared to accept a hike when it does happen. We do not expect any excess volatility when the next hike arrives.

Other Assets

Iron ore prices and oil prices have stabilised after a torrid start to the year. Oil supply has been restricted from the Canadian forest fires and the Nigerian terrorist attacks.

Our dollar fell from $US0.76 to $US0.72 over the month of May.

Regional Analysis

Australia

It looked like there was going to be a landslide victory for the Turnbull government a short while ago. Recent polling is now close with possibly Labor ahead at times. The repeated policy ideas and reversals by the Coalition in recent months seem to have taken their toll. And the changes to super have possibly frightened people – including those unaffected by this round of changes. Whether or not you subscribe to whether the changes are technically retrospective, what walks like a duck …

The RBA inflation forecasts from the Statement of Monetary Policy have taken the range down from 2-3% to 1-2%, but GDP forecasts were unchanged. While we had +10,800 new jobs in May, that growth was entirely due to a big increase in p/t jobs and a big fall in f/t jobs.

Building Approvals grew at +3% when ???3% was expected by the market. Net exports were very strong and GDP growth came in at +1.1% for the quarter, but much of that was from very strong net exports, and not activity at home.

China

The China Purchasing Managers’ Index (PMI) for manufacturing continues to come in at just above the 50 level that signals expanding growth. The services industry PMI continues to be stronger as the consumer side of the economy takes an increasingly important role.

Retail Sales growth came in at 10.1% and Fixed Asset Investment grew at 10.5%. Industrial Production was a more modest 6.0%.

Inflation was a little bit softer than in recent times but China gets a solid tick for its continued economic strength.

U.S.A

It seems that few like either of the major Presidential candidates – Trump and Clinton. Indeed they seem so short on popularity that it is easy to imagine a last minute candidate to take control. Apparently it is possible.

Unemployment is stable at 5.0%, and wages grew a creditable 2.5% over the year. But that behaviour is more like showing ‘signs of life’ rather than pure strength. However, new home sales came in at an eight-year high.

Europe

Germany posted a quite strong growth figure of +0.8% for quarter one. France’s unemployment dipped back into single digits for the first time in a while.

Greece was struggling with its economy and debt repayments but the so-called ‘troika’ have just restructured their debt. We were writing about this in the European crises of 2011 and 2012. No one could then afford to give in to Greece without some ‘tough love’ first. But now that Greece seems to be trying to reform, it is easier to make some concessions.

Rest of the World

Nigeria has lost about half of its oil production due to terrorist activity which, with the production loss from the massive Canadian forest fires, helped restore oil price stability.

The Japanese government is moving a little further away from the ‘big end of town’ in an attempt to restore some economic growth. They also pushed back their scheduled sales tax hike by a couple of years.

India has overtaken China in terms of growth rates. The latest quarter, the economic growth read for India was +7.9%, the same quarter in the previous year, compared to +6.7% for China. India grew at +7.2% in the last quarter of 2015.

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