Economic Update – November 2015

The Big Picture

After two quite bad months on world stock markets, October produced strong results largely based on comments from the US Federal Reserve.

Fed members were on overdrive at the end of September and the beginning of October, to tell all who would listen, that it still plans to lift its interest rate in 2015 for the first time since 2006.

The October Fed meeting produced a statement which dropped the controversial comments about concerns for global growth and volatility. It also upgraded its description of US growth prospects from modest to solid. It is reasonable to conjecture that, had the Fed used those words in September, we would not have seen the big sell-off at the end of September.

The provisional US annual growth figure for Q3 came in at a low +1.5% compared with the twice revised figure of +3.9% for Q2. There does seem a recent tendency for the customary monthly revisions to growth estimates to raise the estimate, so +1.5% on its own is not a problem.

But US jobs data has been a bit softer in the last two months. The next number scheduled to be released on November 6th needs to be back above +240,000 new jobs – the average over the last year or two – to completely calm nerves on this front.

China just cut its benchmark interest rate for the sixth time since November 2014. It is clearly prepared to manage its economy as the other major countries do. Its economic growth came in at +6.9% which was slightly above expectations. Its export data were much stronger than expected.

With iron ore prices falling again in October, BHP and RIO tabled their quarterly results and both produced much stronger production and shipment data. China is still buying, but it is just at a lower price because of the increased supply by the major miners.

China has been flexing its muscles in the South China Seas around its new artificial islands and sovereignty over the waters around them. The US ended the month by sending in a US Navy ship to show that traffic in that busy shipping lane should not be hindered.

General Secretary Xi Jinping visited both the US and the UK in what seems to have been a very successful tour. China has also signed a trade agreement with Australia and the benefits of trade with the UK are already apparent. Going forward, every London cab will have an electric motor made in China, and China and the UK have signed a nuclear agreement. We will benefit too in the medium term.

At home, inflation came in at the low end of the Reserve Bank’s (RBA) target range and unemployment was stable at 6.2%. A few jobs were lost but the general trend for jobs has been solid. These monthly numbers do bounce around quite a lot so it is the trend that is important.

The big take-away from recent data releases and comments is that the pessimism surrounding global growth has subsided but nobody believes the US Fed anymore that they will lift rates in 2015. March or June 2016 is being pencilled in by markets.

But will we cut rates at home? The consensus view is that there will be one or two more cuts but it is so hard to say when they will occur. But with our big banks raising home loan rates without any move from the RBA, a cut sooner rather than later is more likely.

Asset Classes

Australian Equities

There were a few spectacular adverse reactions to company reports and guidance. Woolworths and Dick Smith were hit particularly hard, and the two big banks with significant overseas exposure, ANZ and NAB, did not fare well on their announcements.

Woolworths has been a market darling for a very long time and its cosy position with Coles made market strength a given. But, with new market entrants establishing a presence in Australia investors might be wise to rethink their views of any company likely to face new challenges.

Our market gained +4.3% in October but the last week saw five down-days on the run. We have our market still quite under-priced at -5.5% below fair value. Growth prospects are still strong but we still have to emerge from the recent spells of volatility before a solid up-trend emerges. Santa might bring one!

Foreign Equities

The Q3 US company reporting season produced an unusually large disparity between hits and misses on expectations. This disparity caused some market volatility but the US ‘fear index’, known as the VIX, has been trading at levels well below its average.

The US, S&P 500, had a bumper October gaining +8.3% and the German DAX gained +12.3%. The London FTSE was up +4.9% and the World was up +7.9%. We didn’t even keep up with Emerging Markets that gained +5.4%.

But we don’t see our +4.3% gain in October as a problem. Because our market is closed when Europe and the US is open, and vice versa there is often some nervousness on our part about going too hard on the back of foreign leads – just in case the trend reverses overnight.

Bonds and Interest Rates

After the US Fed kept rates on hold at the October meeting, the market’s odds for a March hike went up to over 60%. The Fed is still talking about raising rates this year but the market has become accustomed to the current situation so no immediate change is now needed.

The Reserve Bank of Australia (RBA) also kept rates on hold again in October and there is an increased chance of a Melbourne Cup cut after the big banks’ home loan rate increases.

Other Assets

Iron ore prices slipped below $50 a tonne from over $55 during October. There was some bounce back in oil prices and our dollar was volatile.

Regional Analysis

Australian employment slipped in September by  5,100 but this read is well within statistical sampling variation of recent stronger results. Inflation came in at around expectations and within the RBAs comfort zone.

But the big change in our economy was the ‘out of cycle’ rate rise by each of the big four banks. The reason for these hikes is simple. Although our banks got through the GFC much better than those in the US, UK and Europe, our regulators have been forcing the big banks to hold an even bigger cushion of cash – particularly, in case if there is any adverse movement in our property prices.

Since cash on a bank’s balance sheet earns a much lower return than a comparable amount lent out for home loans, banks’ profitability would have fallen without some action on their part – so banks lifted home loan rates to restore their levels of profitability. And that means the RBA can now lower rates for general lending without home loan rates falling below recent previous levels. The RBA has to be prudent in the impact of its policies on property prices and any possible overvaluations.

China

China’s imports and exports data in October showed falls but imports fell in line with expectations and exports were almost flat rather than nose-diving as markets had been expecting.

Retail sales data also continued to be strong. And economic growth came in at +6.9% which is just below the +7% target. Officials have again come out supporting continued strong growth but it will be more skewed towards the consumer rather than government spending on infrastructure.

The Purchasing Managers Index (PMI) came in at 49.8 – unchanged from last month. Above 50 is better but 49.8 is just fine.

The China leadership is currently formulating its next five-year plan. But already they have abandoned the one child policy in favour of two. That in itself will boost growth in the medium term.

U.S.A.

The US unemployment rate remained at 5.1% but there were fewer jobs created than anticipated. While the average job creation over the last two years has been around 230,000 – 240,000 a month, the last two numbers came in at 136,000 and 142,000.

But the Fed has improved its view of its economy going forward. It is now saying growth is solid rather than the modest tag it was previously using.
The US is facing a recurrence of the end-of-the-year debt ceiling negotiations to pay for things the government has already committed to!

Europe

With the UK still trying to renegotiate its position within the EU, Standard and Poor’s has announced that it will downgrade UK debt by one notch – or two notches if it leaves the EU and relations with Brussels then deteriorate.

A lot of the issue is how the UK can deal with population movements – particularly from the recent surge in illegal migration. The UK’s generous government benefits schemes are enticing migration to Britain, and that could destroy the system for all. So how can Britain look after its own? Leaving the EU is a strong possibility.

There are three central banks in Europe that now have negative deposit rates!

Rest of the World 

The Reserve Bank of New Zealand kept its rate on hold but there are concerns about dairy exports that underpin the New Zealand economy.

Japan is considering more quantitative easing to boost growth but pulled out of that commitment at the end of October.

There are now apparently 60 million people marching to Europe for safety and a better life. That’s three times the population of Syria and about the same as the United Kingdom. As we wrote months ago, it is not feasible to just try and assimilate them as first suggested by some. And there would be at least another 60 million behind if the first sixty are accommodated.

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

** Australian Bureau of Statistics

Important information

This information is general information only. You should consider the appropriateness of this information with regards to your objectives, financial situation and needs. Infocus Securities Australia Pty Ltd ABN 47 097 797 049 AFSL and Australian Credit Licence No. 236523 trading as Infocus Wealth Management.