Economic Update: August 2018

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

US continues to drive growth!

– The ‘old normal’ is back for the US

– Australian jobs show strength

– China economy still growing at 6.7% p.a.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

The US economy and stock markets powered ahead in July. At the start of his presidency, Trump predicted 4% growth and many scoffed. Quarter two GDP growth just came in at 4.1%! It is now a reality.

Trump also worked out the next step of the trade deal with the European Commission. Albeit rather awkwardly, Trump had a major summit with Putin with more slated to come.

On the inflation front, the US posted a six and a half year high of 2.9% but the Federal Reserve (“Fed”) had already stated that it wouldn’t react too eagerly. That didn’t stop Trump berating the Fed for the hikes already committed. Presidents normally steer clear of commenting on monetary policy but Trump isn’t normal. He is concerned about the effect of the Fed on international trade.

Now that the US has come through ‘the new normal’ growth path that was a popular talking point at around 2008-2010 it is back to the ‘old normal’. That being said, prudent investors and their advisors need to start formulating plans to deal with the standard cyclical behaviour of markets.

There are no major known problems on the horizon but, if the US economy continues to grow rapidly – spurred on by Trump’s expansionary fiscal push – the Fed might be forced to cool the economy. If the Fed is too aggressive, it might hike rates too quickly and cause a recession. That’s how recessions usually start.

With the ‘neutral’ US interest rate at about 2.5%, and two more hikes expected this year, the Fed might well reach that neutral rate in mid-2019. At that time, we will be looking for any signs of emerging excessive monetary tightening.

Since this scenario suggests at least another 12 months growth in markets, it is far too early to be adopting a defensive investment strategy for typical equity investors. On the other hand, continuing a benign ‘hold’ strategy for too long could see some hard-won profits eroded.

It is not just the US that experienced a good month of economic data. Somewhat out of recent character, the Australian economy performed very well. Jobs data were unusually strong – turning the corner for a fading rally in full-time employment.

On top of jobs, inflation came in within the RBA’s target range of 2% to 3% but the RBA’s preferred statistical version of the inflation measure still fell just short at 1.9%. It seems highly unlikely that the RBA will hike rates in the current financial year. A cut is not out of the question if this nascent rally starts to fade.

The China economy grew at 6.7% which is well within the official range of expectations – although one notch down from the previous quarter.

The slightly below expectations inflation read in the UK put an August rate hike as being a little less likely. With the swirling political sentiment around the Brexit negotiations, no hike would be a good outcome.

The European Central Bank (ECB) kept rates on hold but reaffirmed the end to its bond-purchase policy from December.

But for anyone thinking our inflation is hard to swallow, spare a thought for Venezuelan citizens. The IMF just forecast its inflation to be one million percent this year! For us Aussies, that would mean next year, a litre of milk would cost us around $10,000!!!

Reporting season for the ASX 200 just got started. Company forward statements will be the key to gauging the strength of our market.

Asset Classes

Australian Equities

Our ASX 200 was up 1.4% over the course of July. A number of sectors performed particularly well – especially Telecommunications after a very bad 2018 financial year.

It is our belief that the market is only just a fraction over-priced and so a slightly better year for 2018 is still expected – compared to the long-run historical average.

August (and February) can bring surprises as companies report their full or half-year financial results. Normally there is a ‘confession season’ just prior to reporting for those companies likely to miss prior guidance. This time around, the season has been quiet. That is good news.

Foreign Equities

The US and world indexes have performed particularly strongly in July. We believe 2018 will be another good year for Wall Street. But, as we foreshadowed in our summary, now is the time to realise that normal conditions are back. It seems unlikely that a downturn or correction is likely anytime soon but we need to get our mindset back into gear.

Markets go through good and bad times (but good in the long-run). With the so-called quantitative easing from central banks around the world largely behind us we should not just assume markets will keep going up.

That is not to say that we are predicting a bear market or even a down turn – but we should dust off our notes on how to deal with markets that are turning. Complacent investors will, eventually, get burnt!

Bonds and Interest Rates

The chance of a September rate hike by the Fed has been questioned by El-Erian, the former co-CIO of the bond fund giant, PIMCO. The market is pricing an August rate hike at 91% while he is only prepared to commit to “above 50%”.

In this new world of strong economic growth, it is so important that the Fed doesn’t run ahead of the curve or markets might get spooked.

The RBA, BOJ and ECB were all on hold in July and the chance of a BOE hike in August diminished after weaker-than-expected inflation

Other Assets

Prices of copper and oil were down on the month; iron ore prices were up. The Australian dollar was flat against the US dollar. None of these results were big enough to worry markets.

Regional Analysis

Australia

The five by-elections at the end of July produced predictable results and, historically, by-elections do not favour the government.

The 50,900 new jobs posted in July was a big beat and even the trend numbers were very strong. The unemployment rate was 5.4%.

The labour force results are not strong enough to tempt the RBA into hiking rates anytime soon. Headline inflation was only just in the target zone at 2.1% while the RBA-favoured ‘trimmed mean’ was just shy of the range at 1.9%.

China

The monthly China data drop was a little less positive than in recent months but the 6.7% GDP growth was spot on what the official position was asking us to believe at the beginning of 2018.

The China manufacturing PMI came in at 51.2 against an expected 51.3. The services variant was 54.0 after 55.0 the month before. Since there were adverse weather conditions and trade-war talk abounded, these results are very strong. Anything above 50 is strong.

US

Did Trump play us and Putin with his ‘mis-speak’ of his views about his own intelligence experts? Trump continues to annoy much of the observer base. But there are too many successes – so lacking in the last decade or so – to ignore him. Whether fool or genius, the US keeps on coming out in front.

The European Union has been a hot-bed of protectionism since inception. Trump played his hand into the close and seems to have won big concessions. Juncker, the European Commission President, came out of the White House summit ‘on side’ and markets rallied hard in the next 30 minutes or so to the close on the day last week.

Kim Jong-Un of North Korea has gone quiet. Putin and Juncker are on side so there is only China left to deal with. And Trump seems to be getting there as well. All of this bodes well for a stable geopolitical future for us all.

Europe

The UK’s PM, Theresa May, seemingly had a win in her parliament but the ‘Brexit minister’, David Davis almost immediately resigned. Boris Johnson, the Foreign Secretary, followed Davis out of the door and a challenge to May looks on the cards. March 2019 is the deadline for getting a Brexit deal done and dusted. The issues and possible exits are far too complex to judge at this stage.

The ECB is coming to terms with life after quantitative easing. Its economy isn’t raging but nor is it a problem anymore.

Rest of the World

Venezuela, once a successful oil producer, is now facing inflation of one million per cent (according to a recent IMF report). Naturally there is social and political unrest but there is no obvious spill-over into our fortunes. Some sort of foreign aid may well be on the cards.