Economic Update

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

It’s been all growth on Wall Street

– United States (US) tax reform

– Australian economy is warm at best

– Japan economy is on fire

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 Big Picture The third quarter of 2017 just ended with Wall Street’s S&P 500 index not only posting a positive return – but it posted the eighth successive quarter of growth! Indeed, the last six months were also all positive.

So where did we go wrong? Out market has moved sideways since May in a very tight range. Basically, expected earnings for companies on the ASX 200 just aren’t cutting the mustard. But the growth in earnings on Wall Street has been sufficient to justify their index returns over the last two years.

On top of that, Trump has started to articulate his tax reform package. The details are sketchy at this point but the right noises are being made both in politics and in business.

Our GDP growth came in at a moderate 1.8% for the year which was more or less in line with expectations. We had more strong jobs data but what will come next? The Reserve Bank (RBA) is upbeat. The worry is that they will get too enthusiastic and pull the trigger for a rate hike making the wheels fall off.

Turnbull at least got one win on the energy policy but we need more.

We reported last month that Japan’s economic growth was strong at 4%. This month, Japan export growth ran into double digits for the second month in succession. So good is it that Shinzo Abe has called a snap election. He wants to usher in a big stimulus package and make a more concerted stand against North Korea.

China data over September was a little softer than the previous month but still strong. The new politburo will be ushered in this month for its five year term. The infrastructure highway across Asia and into Europe will put massive demands on steel production – and we are in a position to help. BHP was very vocal and positive last week!

Angela Merkel was returned as Chancellor in the Germany elections – but with a different blend of coalition. Not a resounding success! New Zealand elections were even more wishy-washy.

The one to watch is the UK. Its inflation read came in at a lofty 2.9% – well above the pack. The Bank of England will start tightening soon.

October is going to be very special indeed for central bank watchers. The US Fed has announced that it will no longer buy back all of the bonds that mature. In a sensible and staged fashion, they will very gradually reduce the 4.5 trillion dollar debt to about half of that over a few years.

Most commentators believe that will put upward pressure on long bond rates. There has already been some impact in this direction on the expectation of this ‘balance sheet repair’. That’s all good and necessary. But what will happen at the short end? Will the Fed still hike its fund rate?

It surprised many – including us – that in the latest minutes, the Fed is still planning on one more hike this year (December), three next year and two the year after – down from three. We do not think it wise to hike rates while it is commencing budget repair.

The current chair – Janet Yellen – has her term up in February and Trump has signalled he will announce the next chair in the next 2-3 weeks. Depending on the views of the new chair (or Yellen if reappointed) we could be in for a bit extra volatility to go down with the Christmas turkey. But US growth and tax reform should steer us through any bumps along the way.

Asset Classes

Australian Equities

The ASX 200 was down slightly ( 0.6%) for the month but the index is up only +0.3% for 2017 to date (plus dividends makes a total return of +3.9% including franking credits).

So being in equities for 2017 would have been better than cash but there is a sense of frustration among investors.

Since May we have had the tightest range on record for the index. Of course it will break one day but there are a lot of factors at work. Some have suggested that local super funds buy in strongly at around 5,650 but foreign funds sell at above 5,800.

Such behaviour means that we are living off our rather lucrative franked dividends. Not bad if you can get it.

We think we need three things to change before our market takes another ‘leg up’. First, we need our political system to engage on tax reform and infrastructure. Second, we need the US Fed to clearly articulate its plan for the next year or so. Third, we need the soon-to-be-sworn-in China leadership team to announce its new plans. On this basis it is hard to get excited about potential gains in October but we could get a really good Santa rally – and not because it is that time of year. It is that confluence of events.

Foreign Equities

The S&P 500 was up 1.9% over September. The German DAX was up 6.4% and the Tokyo Nikkei was up 3.6%. So there was a lot of action but it is hard being in the right markets at the right time.

Going forward, it is probably smart to be weighted a little out of Australia and towards Europe and Emerging Markets with a healthy – but not overweight – stake in the USA.

Bonds and Interest Rates

The RBA was on hold in September and will hopefully not raise rates until at least 2019. But some commentators are calling for a hike in early 2018. They must use a different crystal ball supplier.

We expect some volatility towards the end of 2017 as the Fed sorts out its new direction. And there is pressure on the UK to hike.

While we expect volatility, we do not expect a long-run impact on our markets. We have lived in a low volatility regime for much of 2017. If volatility goes back to normal levels, so what?

Other Assets

Oil prices were up about 10% while iron ore was down about 20% over the month. In both cases, these changes are not establishing new trends but correcting previous moves.

Regional Analysis

Australia

While economic data last month came in reasonably positively, the data were not strong. The future could go either way. Recessions and the like are way out of line but slow to moderate growth is possible.

On the other hand, a concerted effort by the government and the RBA could make things happen. But our media seems centred on causing conflict. We need a circuit breaker and one isn’t stepping up to the plate!

China

The China data in September was a bit light on but nothing to worry about. There is always statistical variation. In October there will be a new leadership team to run the second biggest economy in the world.

The Purchasing Managers’ Indexes (PMI) which look forward, were very strong. The manufacturing index came in at well above the ’50 mark’ that indicates strengthening expectations. At 52.4 it was actually at a five year high. The services PMI was even stronger at 55.4 which was a three year high. Not much to worry about there!

China debt was downgraded in September (but so was UK debt). The new massive infrastructure programme is likely to change the world order and we should benefit. But it might take a while for the flow on to take hold.

US

Trump has had no real wins this year but the tax plan might make it. So far there is no real plan but there is enough at least to get his own team on side. To cut the corporate tax rate from 35% to close to 20% would have a massive positive impact. It has to be funded (at some point) but there is lots of wiggle room.

The jobs data were a little bit soft in September but one month does not make a trend. The average for 2017 job creation is the same as the 2016 average.

Europe

Brexit dominates but the noise seems to be subsiding. Naysayers seem to want the UK to fail but the leaders are being measured.

Europe is now so far from the basket case it was a few years ago, it can work its way through this. With the all-important German and French elections behind us we can look to the future. The European Central Bank is unlikely to upset the balance.

Rest of the World

North Korea has seemingly gone quiet after China closed ranks with the West on the recalcitrant North Korea. That will help markets.

But the big ‘Rest of the World’ news must be that Saudi Arabia is now allowing women to drive cars. Hopefully no one thinks that women shouldn’t be allowed to drive but when half of the population suddenly gets a learners permit after many years in the passenger seat, what chaos can follow? Robot-driven cars are needed quick-time.

By Ron Brewley on behalf of Infocus.

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

Economic growth improves in key countries
– China economy shows strong signs of strengthening
– Australian employment data continues strength
– Rates on hold in Australia and the United States (US)

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

There were some notable economic growth numbers released in July. After a few years of declining (but still stellar) growth numbers in China, the latest statistic was back up to 6.9%. The new China leadership team is about to be ushered in and the Chinese know how to throw a party. On top of that, the China Purchasing Managers Index (PMI) came in at 51.4 for manufacturing and 54.5 for services – both in the sweet spot. Throw in 11.0% for Retail Sales and 7.6% for Industrial Output and you have what Keating might call, ‘a beautiful set of numbers’.

Turning to the US, the anaemic growth in Q1 was overshadowed by the June quarter coming in at 2.6%. True it’s not the 3% that the Fed is aiming for or the 4% that Trump was dreaming of. But 2.6% is really solid. Unemployment is low at 4.4% and 222,000 jobs were created in June when only 180,000 new jobs were expected. It is true that wage growth was low at just 0.2% but you can’t have everything all at once can you?

Even Australia was looking good. We had some very nice jobs and unemployment data – against the trend of 2016. For whatever reason, the labour force data are looking better. But the RBA chimed in at the start of July saying that 3.5% is our ‘neutral’ interest rate. That is, rates should be at 3.5% when things are chugging along. Since we are sitting on only 1.5%, there are a lot of hikes in the pipeline!

It was a bit silly to advertise that opinion just now and an Assistant Governor had to come out and hose things down. Retail sales did come in at a biggish 0.6% for the month. We’re not cooking on gas but at least we are cookin’ again.

As we go around the world the United Kingdom (UK) is starting to struggle a little with its latest growth of only 0.3% for the quarter and Brexit looming large. Prime Minister Abe in Japan has gone from rock star status to a meagre approval rating of 29.9% in a few years. The Royal Bank of Canada bumped up rates to 0.75% from 0.5%.

So the dice are still rolling. Fortunes are rising and falling but there seems to be no basket cases anymore and there is lots of good news.

We became aware of a new expression this week. It’s been out but under the radar for a few years. It’s still worth sharing. On asking why stock markets – particularly in the US – remain strong – the new catch phrase is that it is a TINA market. Not as in Turner or Arena, but it is the acronym for ‘There Is No Alternative’. Money has to be invested somewhere when cash rates are so low.

TINA puts a safety net under markets for a while but we must be vigilant for when Tina starts singing.

So where to from her? Trump is floundering but his economy is doing well. The Australian economy seems to have stabilised. To us, it looks like a smooth ride ahead – until we see otherwise.

The current US reporting season has been unusually strong meaning that increases in earnings are supporting recent stock price strength. Can it go on? In a word, yes!

The big Tech Companies are having mixed results but they are looking strong. We should never be complacent but the second half of 2017 doesn’t look too bad at all. Perhaps we all deserve a break after the trials and tribulations of 2008 – 2015.

Asset Classes

Australian Equities

The ASX 200 was flat for the month of July. The Materials sector was the strongest on the back of some very strong commodity price movements. Healthcare took a beating at  7.5% with Utilities ( 5.3%), Telcos ( 4.3%) and Industrials ( 3.2%) not far behind. Financials (+1.2%) put in a creditable performance. A big sector rotation just took place.

Our August reporting season is just getting underway. As always, the companies’ outlook statements will be crucial for the future of our market. We have found some recent softening in broker forecasts of company earnings and dividends. At least that downgrade has resulted in our forecasts for capital gains to be only a tad under the long-run average.

Foreign Equities

The S&P 500 fared a bit better than us in July posting a solid +1.9% capital gain. The London FTSE also did well at +0.8%. Emerging Markets were particularly strong at +4.1% on the rising tide of commodity prices.

Our expectations for Wall Street are for a good finish for the year despite the strong first seven months of +10.3%.

Bonds and Interest Rates

With the “Fed” (US Federal Reserve) on hold again in July, the next chance for a hike is at the September meeting. But most forecasters are not expecting another hike this year. The odds of a rate hike by December are priced in at a little under 50%.

The Fed is widely expected to start its balance sheet repair in September. This amounts to gradually lowering the $4.5 trillion bond debt down to $2.5 trillion over a number of years. Since this policy will gradually raise long rates on its own, there is no reason for the Fed to also raise the underlying Federal Funds rate at the short end.

The RBA kept rates on hold again in July and August. The majority of pundits are expecting the next move to be up but not until at least the middle of 2018 – and possibly 2019.

Our view of needing a cut at home is on the back burner for the moment. We need a little more data to change our call. It all depends upon the next GDP growth number to be posted on September 6.

Other Assets

Commodity prices were on a flier in July. Iron ore was up +15.2%, Brent Oil up +9.8% and Copper up +6.2%. Our dollar was up +3.8% against the greenback.

The volatility index called the VIX was down  3.7% in July. This fear index is around all-time lows.

Since we are a commodity producing and exporting country, the restoration of solid commodity prices bodes well for our total exports and GDP growth.

However, not everyone wins from this sectoral rotation. Healthcare and a number of Industrials names are finding stronger headwinds after a good first half to 2017.

For example, our Healthcare sector is up +13.0% for the year-to-date including the poor  7.5% for July.

Regional Analysis

Australia

Our headline CPI inflation came in at only +0.2% for the quarter or +1.9% for the year. Since the RBA’s target range is 2% to 3%, this read gives the RBA no motive to raise rates anytime soon.

With total employment up around 170,000 in the first half of 2017 – with nearly all of them full-time jobs – we are back on track. During that period, the unemployment rate has been stuck at around 5.6% and wage growth is non-existent.

Europe

The focus in Europe is on what the implications of Brexit are for employment and trade. It will be nearly two years before we find out the full story so we cannot expect much good news from that region in the medium term.

However, the underlying economies are so much stronger than in recent times. We don’t have to waste much energy worrying about Greece and the other ‘PIGS’ countries anymore. Can you remember what PIGS stands for? Those days are gone!

China

The China data have been on a roll for quite a while. Without taking sides, it is hard to conclude after recent data that China is not undoubtedly doing well at the moment. Yes, there are political problems with the US and who would want North Korea as a neighbour – let alone an ally.

But what seems to be forming is a view that China has regained its role as a lead player in the world – as solid and dependable – at least in an economic sense.

US

Trump is hiring and firing quicker than he did on “The Apprentice” – but the West Wing is for real.

The US is facing a number of problems in a month or so but these ‘episodes’ on TV have not stopped US jobs and growth.

We don’t think anyone can reliably predict how this scenario will play out but, as annoying as the tweets and press releases are, the economy is marching on!

Rest of the World

With sanctions on Russia being on the front burner, and the woes of the Venezuelan leadership also up there on many news wires, some instability in oil pricing is likely. Both countries are big exporters.

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

March could have gone either way. We were waiting for: a big rates decision by the US Federal Reserve (“Fed”), Trump’s first bill through Congress on Obamacare; the UK actioning of “Brexit”; and the usual plethora of statistics.

March turned out much better than most expected – particularly for the Australian stock market. Janet Yellen, the Fed chair, must take most of the credit. She played the markets beautifully by talking up – well before the meeting – the number of rate hikes for 2017 and the renewed strength of the economy under Trump.

The market locked in an almost certain March hike. The market had already priced in the hike so that wasn’t taken as a negative signal when she pulled the trigger. And Yellen said at the press conference the hike showed the economy had sufficient strength – but she hosed down notions of more than the three hikes the Fed had flagged after last December’s meeting.

The net result was that markets were very happy because all the recent talk of four or more hikes had gone away. It felt like a rate cut! The United States (US) jobs data were very strong in March and inflation was just under the target rate. A great economic mix!

The Republican Party embarrassed itself by not agreeing on the changes to Obamacare (Affordable Health Care Act). There is a new faction of about 30 Republicans – including the Tea Party members from the Sarah Palin days – that have extreme right-wing views. In short, the so-called ‘Freedom Caucus’ simply disrupted.

Trump handled the defeat well. He just moved on to the next bill which is on tax reform. In some sense that has accelerated the short-term economic plan – and markets liked that too.

Is it not surprising, therefore, that the US recorded its highest consumer confidence reading in 16 years – and it was much, much stronger than the month before. The media are less than kind to Trump but the population obviously loves what he is doing.

China also impressed with a very good manufacturing number, reasonable retail sales, and a target of 6.5% economic growth for 2017. On top of that they recorded the strongest producer price inflation in nine years. That sort of inflation is very good because it measures how much businesses are earning.

The UK has now actioned ‘Article 50’ which means the Brexit must be complete by March 2019. The UK economy jogs along at a brisk pace against the predictions of the many who thought it ‘would mark the end’ for Britain.

Sydney house prices posted another strong quarter making for a very rapid rise since late 2013. However, if we go back a decade further, Sydney house prices were flat or down when compared to the CPI! At one point, the market was down nearly 15% against the CPI from late 2003. The market has just played catch-up.

It is a fact that average house prices usually go through extended periods of stagnation followed by a handful of years of rapid growth. From 2003 to today, Sydney prices have only averaged +2.5% p.a. faster than the CPI. Yes – that makes it harder for people to get into the market. But it is not the stuff of bubbles and property crashes.

In our opinion, the banks are safe from a housing crash so the ASX 200 is safe and the RBA has room to cut rates to help the sagging labour market. So why don’t they? The big banks are starting to raise rates on their own!

One should never rule out markets being side-swiped by some unpredictable event. But conditions seem very stable for the medium term. Market volatility has been unusually low through March.

Asset Classes

Australian Equities

The ASX 200 had a wonderful March gaining around 3.3% on the month including dividends. The ASX easily outperformed Wall Street and London. As such it was playing catch up.

We noted that, towards the end of the month, the ASX had strong days when the lead-in from overseas was weak. The market breached 5,900 for a few minutes on the last day of March. Our January 1 forecast for an end-of-year value of 6,000 is very much on track.

Most sectors performed well in March. The broader index was brought down by Materials, Property and Telcos.

Foreign Equities

Wall Street was flat over March. We take this behaviour as a sign of strength since Wall Street had run so hard since the November 8th election. Strong rallies often end in corrections of 5% or more. So far Wall Street has avoided a correction in this rally.

Indeed, market volatility and the VIX ‘fear’ index have been particularly low in March. We interpret these statistics as pointing to the market simply taking a ‘breather’ rather than marking the end of the ‘Trump rally’.

Bonds and Interest Rates

The market appears to be pricing in one, or possibly two more hikes by the Fed this year. We always doubted the Trump effect bringing actual economic stimulus before 2018 – although we believe it will come. It just takes time to put new policies into action.

The ECB kept rates on hold in March, as did our RBA. That has not stopped some of our banks raising home loan rates for both owner-occupiers and investors alike.

Other Assets

Iron ore prices fell from an unexpected high in February but market commentators are generally confident about prices remaining solid for the rest of the year. Oil prices also slipped but then stabilised.

The Australian dollar was flat over March but moved in a two cents range.

Regional Analysis 

Australia

The unemployment rate jumped up to 5.9% for February but retail sales came in at a respectable +0.4% for the month. We see no government or RBA action on the horizon to improve the situation.

Labor had a resounding victory in the WA elections and the government slipped further in the polls. However, the swings in popularity are not coming from better economic policies to promote growth but negativity about the incumbents’ policies.

China

China really has solidified its position as a strong economy. Some doubted its strategy a year or so ago but pessimists are relatively few and far between these days. It was particularly pleasing that its producer-price inflation was so strong.

Of course there are always political risks when the China economy is being analysed. In particular, it is not clear what Trump will try and enact and recent dealings between China and Australia were slightly destabilising.

U.S.A

The jobs data were again strong with the unemployment rate coming in at 4.7% which some Fed members consider is lower than full employment!

The main risks associated with the USA are related to Trump’s ability to get his bills through Congress. That he has moved across the aisle in an attempt to woo Democrats is essential as long as he cannot rely on his ‘Freedom Caucus’ to vote with the rest of the Republican Party.

That Trump is moving on to tax reform next is important as there is likely to be more agreement across factions on that front. Experts on US TV have put August down as a likely time for putting a tax bill before Congress. However, given the backdrop, the timing of the bill is inherently uncertain.

Europe

The Dutch decided not to vote in a party that favoured leaving the EU. On that same vein, France’s presidential election seems likely to favour the status quo.

Donald Tusk was re-elected as EU Commission president. And the ECB chair, Mario Draghi, has spoken on not needing to loosen monetary policy any further. Indeed, he spoke in terms of one day tightening!

Rest of the World

North Korea continues to be a major worry for us all. Japan wants to up its missile capabilities to counter the North Korea build up.

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