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

US trade deals

– US strikes a deal with Mexico over trade
– Global growth under control
– Australia gets yet another PM!

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 reported progress on trade talks with the EU. Then the US struck a trade deal near the end of August with Mexico – and markets loved it. But then Trump talked of leaving the World Trade Organization (WTO) and the market pulled back a fraction. Big US tariffs on China imports are due to be imposed by September 6th if a deal isn’t struck before.

Such is the Trump style of negotiating – big threats followed by deals. All this trade talk means short term volatility and long term growth. The US quarter two economic growth statistic was just revised up to 4.2% from 4.1% and recent China trade data were robust to the trade chatter.

The US Fed’s preferred measure of inflation just came in at 2% – in the sweet spot. Chairman Jay Powell stated that the US economy is not overheating but the Fed is expected to raise rates a notch in September and possibly once more in December. All this hiking does is to get the rate back to the so-called ‘neutral rate’. Monetary tightening only occurs if the rate is pushed up above the neutral level and that’s not expected until at least mid 2019.

In spite of the S&P 500 reaching new highs at the end of August we see no reason to start reducing US equity exposure. But, of course, we monitor the situation.

The Bank of England raised its rate for the first time since the GFC. The economy was looking in a bit of trouble until last week when hope of a Brexit deal was heightened by favourable comments from Europe.

On the other hand, the Reserve Bank of New Zealand pushed back its forecast for its next rate hike until quarter three, 2020. We read all of these signals as showing that central banks are reacting in measured steps that can support continued synchronised global growth.

There are some difficulties in emerging markets. The Venezuelan and Turkish economies are still struggling and Argentina just raised its interest rate from 45% to 60%! We do not expect these emerging market issues to impact on global growth. China is ready to act when needed and President Xi was admonished for being too aggressive over US trade talks.

At home our jobs’ report was very solid. The unemployment rate at last fell and full-time employment growth started to improve.

Perhaps a better sign for our economy has come from the listed companies’ reporting season that just concluded. There have been many ‘beats’ where companies have improved earnings over expectations and their share prices have been justly rewarded. Of course some companies under-performed and some of these share prices were savaged.

August was a positive month for the ASX 200 index but fund managers and investors could easily have found themselves well above or below the index depending upon the positions they took – such was the dispersion of stock returns.

While the Reserve Bank of Australia (RBA) has been on hold for two years and expected to do so for many more months, Westpac just raised its flagship home loan rates by 0.14% points. Because banks do not borrow funds from the RBA to disperse to home loans, they must refer to their actual costs of funding. Much of this funding comes from overseas and those rates have been drifting higher.

After a number of surprise moves in Canberra, Australia now has a new prime minister in Scott Morrison. Unlike one of the contenders, Peter Dutton, Morrison is expected to continue the current thrust of policy but with a more elector-friendly spin.

Asset Classes

Australian Equities

Our ASX 200 just completed its fifth successive month of capital gains – putting such slogans as “sell in May and go away” in the place they deserve to be. Indeed, three sectors (Health, IT and Telecommunications) produced double digit returns in August alone. The Materials sector was the biggest loser.

With the August reporting season all but complete, and recent earnings strong, the index looks set to continue modest rises into at least the end of the current financial year. There have not yet been any signs of material changes for earnings’ prospects as summarised by consensus forecasts.

Foreign Equities

The US’ S&P 500 has also enjoyed five successive months of capital gains and its bull run – now the longest in recorded history – looks set to continue. The new all-time high of just above 2,900 is well short of the 3,030 ‘sell signal’ we are using as a guide until the end of 2018.

Bonds and Interest Rates

The US Fed is widely expected to increase the funding rate at its September meeting. But what will be more important is the so-called ‘dot plot’ that shows the individual committee members’ expected rates over the next couple of years. The Fed is independent but Trump has been attempting to lean on the institution saying that he thinks rates are already too high.

Germany has withdrawn its support for a German to replace Mario Draghi, President of the European Central Bank, next year when Draghi’s term expires. Since the German was thought to be hawkish – meaning that he would increase rates faster than currently being considered – there is now less chance of emerging economic problems in Europe. Germany has, instead, put its weight behind electing a German for President of the European Union.

With Westpac being the first of the big four banks to raise its home lending rates, the others are expected to follow in short order. If this pattern is indeed established, Australia will have had a de facto rate hike without intervention by the RBA. Not only does this situation push back forecasts for the timing of the next RBA rate hike, it increases the chances of a rate cut.

Other Assets

Prices of gold, copper and iron ore slipped over August but oil prices firmed.

Regional Analysis

Australia

The RBA’s Statement of Monetary Policy revealed the bank is not expecting the unemployment rate to dip to 5.0% until December 2020. Given that the latest read was 5.3%, the bank is clearly not expecting much in the way of economic activity for some time. Indeed, if it were not for strong immigration-fuelled population growth, our rate of economic growth would look very poor indeed.

The new prime minister will have his work cut out to restore growth prospects in the few months left before the next election. Josh Frydenberg, the new treasurer, has a strong background in resources and energy. With electricity prices a major problem across Australia, the new Energy Minister, Angus Taylor, has come out on the front foot in the debate.

China

China imports grew at a stunning 27% while exports grew at 12% against an expected rise of 10%. China trade is holding up in spite of all of the trade threats and negotiations.

On the other hand some of the domestic statistics were a bit softer than expected: retail sales; industrial production; and fixed investment. China is reportedly poised to act if and when necessary.

US

Two people close to President Trump’s campaign have been found guilty of some serious charges but these charges do not relate to any possible Russian involvement. While the situation reflects poorly on Trump it seems highly unlikely that he, himself, will be drawn into the legal fray.

That Trump negotiated a new ‘better’ trade deal with Mexico should be emphasised. Trump has many detractors and they must feel overwhelmed by this clean end to the Mexican trade dispute. So much so that Canada immediately stated that it was now close to a new deal with the US which means the long-standing NAFTA arrangement has been improved upon for the whole region.

With the mid-term elections approaching, these deals could help Trump keep control of the House of Representatives. If he loses control, he would find it very hard to continue his policy agenda in the following two years of his presidency – a so-called lame duck presidency.

Europe

At last the UK has found some support from Europe for its Brexit trade deal to replace that with the European Union after March next year.

Germany reported its latest economic growth statistic to be 2% which is reasonable but not great. There is a growing movement of right-wing sympathisers in Germany who apparently feel that they are being marginalised by Berlin compared to the government assistance for the new large refugee population.

It is seven years since the onset of the ‘European crisis’ involving mainly Portugal, Italy, Greece and Spain financial institutions. There was then much talk of a ‘Grexit’ that was concerned with the implications of Greece leaving the common euro currency. The major ratings’ agency, Fitch, just upgraded their national debt which is a good step towards a stable Europe. Greece’s austerity program has at last produced economic stability.

Rest of the World

Turkey started to repair its damaged reputation for economic management and its lira stabilised. However, some volatility remains but it has not spilt over into other emerging markets to the extent that some feared.

However, Argentina’s separate woes are escalating. Its central bank just raised its official rate to 60% from 45%.

The “omnishambles” in Canberra – what are the implications for your financial future?  

If you haven’t heard that word before, it was being bandied about this morning by the media to describe the diabolical political situation in Canberra. According to Google it means “a situation that has been comprehensively mismanaged, characterised by a string of blunders and miscalculations.”

As with many Australians around the country today, you will no doubt have been eagerly anticipating the outcomes of the current political crisis in Canberra. Malcom Turnbull confirmed yesterday that he would call for a meeting of the party room after 12.00pm (AEST) Friday 24 August 2018 if Peter Dutton was able to deliver a petition with at least 43 signatories on it. Malcolm Turnbull confirmed that he would not contest the leadership and as a result would quit parliament.

Well, after a protracted, concerted and disruptive effort by the conservative right-wing of the Liberal party, we now have a new prime minister-designate, and perhaps surprisingly, it is not Peter Dutton. In what you might call severe mismanagement and miscalculation from the “Dutton camp”, in a three way race (which saw off former foreign minister and deputy PM, Julie Bishop), Scott Morrison now leads the Liberal party, with Josh Frydenberg winning the position of deputy.

What are the implications of this for you and your family and for your business?

Much is still unknown, but from a helicopter perspective, the question now will be whether the new PM, Scott Morrison, can rally the party and form a cabinet that can restore the party, create stability and continuity and improve the confidence of voters between now and the next Federal election, earmarked for May 2019. If he can, the Coalition’s policies are known and are in place and we would imagine, apart from any kind of cash-splash to woo voters prior to the election, it will be largely business as usual (not forgetting the challenges the Government has regarding energy security and affordability under the energy guarantee and the backdown on the corporate tax breaks). But if they can’t shake the negative outcomes of the abovementioned “omnishambles” and Labor wins the Federal election, what are the implications for wealth creation, superannuation, social security, personal and business taxation and retirement?

Since the recent changes to superannuation which have introduced a $1.6m transfer balance cap to limit what can be used to fund tax-free retirement phase pensions, and to limit further concessional and non-concessional contributions to super and the myriad other measures we are all aware of, Labor has not released any final policies which would seek further changes to superannuation. But in terms of wealth creation, generation of retirement income and personal taxation, Labor has been quite plain on three measures they intend to implement if they win government, namely changes to restrict negative gearing to new housing, reducing the capital gains tax discount and putting restrictions on franking credits (which Labor did temper following significant blowback from the community). For other policy issues such as penalty rates, child care funding and social security reforms, school funding, health spending, tertiary education and the outcomes of the banking royal commission, a mandate for substantive change will come down to numbers and in some sense the timing of the election.

Is it probable that an election will be called earlier? No, not least because the Coalition does not have the candidates on the ground and the question concerning Malcolm Turnbull’s prospective resignation from parliament, potentially forcing a bi-election in Turnbull’s seat of Wentworth. The Speaker of the House makes the call on a bi-election and may decide to defer until the general election. However, Malcolm Turnbull has not made an announcement on his position and he may stay to support Scott Morrison in his challenge to retain government. Regardless, Scott Morrison and Josh Frydenberg have a challenging task ahead of them to unite the party.

We will keep you informed of any changes as they are announced and will work closely with you to ensure that whatever happens and whoever is in government following the next election that your financial strategy is best able to adapt to any legislative and regulatory uncertainty. Please do not hesitate to contact us with any questions.

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.