The risk of President Trump’s
impeachment increased in September with Democrats instigating the first stages
of the process. The seriousness for US markets will take time to play-out but
political focus is likely to drift from the economy and the US budget. In the
United Kingdom the Brexit outcome remains chaotic making it difficult for
investors to have confidence.
The continuing threat of
geopolitical conflict disrupting the smooth functioning of economies was also
evident in September. The attack on the Saudi Arabian oil refineries resulted
in the oil price spiking short-term. Oil reserves and the ability to repair the
damage quickly alleviated the immediate impact.
US
Interest Rate Bounce
Interest rates in the US bond market fell dramatically in August. The US 10-year government bond rate fell half a percent, one of the largest monthly falls since the Global Financial Crisis (GFC). This resulted in a predictable response from borrowers in early September to the low rates with a rash of bonds being sold into the market. The US corporate bond market had record issuance on 8 September with 49 deals in 30 hours totalling US$54 billion. Even cash rich Apple took advantage issuing US$7 billion of bonds including a US$1.5 billion 30-year bond paying 2.99%. The US Government was also encouraged by the low rates to refloat the proposal to issue very long-term bonds of 50 years.The overall trend in interest rates remains “lower for longer” but the trend has not been smooth. United States interest rates bounced back in mid-September. This unsettled the share market and investors switched from high priced revenue growth shares to more traditional profit generating companies.
Over recent years markets have been
focused on growth over value. September may represent the first signs of a
pivot between these two strategies.
Central
Bank Policy
Central banks are concerned with the
long-term management of financial conditions focusing on inflation and
employment levels. In doing so they look through the short-term fluctuations
experienced in the market. A number of central banks delivered policy
statements in September. Generally, these statements were consistent with
investor expectations. The Federal Reserve delivered a quarter percent cut in
line with market pricing. The Bank of Japan kept monetary policy steady but
signalled it could ease next month. The Bank of England kept rates steady at
0.75% and the RBNZ similarly held the Official Cash Rate (OCR) at 1%. Post its decision to reduce the US benchmark
rate the Federal Reserve has had to intervene in the overnight cash market on
numerous occasions and provide additional cash injections as cash rates rose
above the target levels. This is the first time the Federal Reserve has had to
intervene in this manner since the GFC. The liquidity problem appears to be
more technical rather than a reflection of wider fundamental problem but may require the Federal Reserve to once again expand its
balance sheet.
Central bank monetary policy
implementation reflects actual and anticipated conditions in the real economy.
Increasingly, the economic outlook is subdued, and hence central banks are
continuing monetary stimulus. However, economists are challenging the
effectiveness of such policies in isolation. The effectiveness of monetary
policy alone is diminishing, and central banks are calling on governments to
undertake more fiscal policy (increased government spending or tax cuts) to
support economies.
Trade
War Impact
The US economy has been only
moderately impacted by the trade war to date, but the signs of increasing
effects are becoming apparent. US GDP growth and inflation remain reasonable
but below target and below prior levels. US GDP for the second quarter remained
at a 2% annual rate. Inflation using the Federal Reserves’ favoured measure was
1.9% annualised just below the 2% target. US job growth in August was lower
than expected but unemployment has held at a steady and very low level of 3.7%.
The US consumer remains healthy, but consumer confidence slipped in September.
Signs in the industrial segment are less positive. The Cass freight index
dropped 3% in August the 9th month of consecutive declines. Surveyed
manufacturing activity declined in August for the first time since early 2016.
China is also experiencing a slowing
of its economy. The Chinese manufacturing index for August showed contraction
whereas non-manufacturing in August was expansionary. Exports fell in August by
1% year on year. The Chinese economy perhaps is not being as severely impacted
as expected as the Chinese government took early action. Monetary stimulus is now
being followed by fiscal stimulus and the authorities have further levers to
pull. China appears to be positioning itself for a long-term impasse with the
US developing technology internally and diversifying external trade relations
so as not to be as reliant on the US.
Australasian Effects
The health of the Chinese economy
directly impacts on the export earnings of Australia and New Zealand and the
general buoyancy of the Australasian economies. Australia achieved a current
account (trade in goods and services) surplus of A$5.9 billion in the June
quarter, the first current account surplus in 44 years. This result occurred
despite the fall in coal and iron prices which may show up in future quarters.
Australian GDP continued to grow at a rate of 1.4% year on year, but this is
the slowest rate of growth in 10 years. The jobless rate has remained above 5%
in Australia despite the cuts in interest rates by the RBA.
New Zealand similarly has a positive
but slowing rate of GDP growth. In the June quarter GDP growth slowed to 2.1%
annually, a five-year low. Services sector activity remained buoyant in August,
but the manufacturing index contracted.
Similar to the United States New
Zealand borrowers were active. There was overall bond issuance of $3.2 billion
in September and bond maturities of $314 million. The New Zealand Government issued $2 billion
of bonds in September including $250 million of 2025 bonds. Demand for the 2025
bonds was strong with $810 million bid. However, despite the 3 times cover, the
interest rate was not bid lower for the first time in 8 consecutive bond
tenders.
Europe
Continues to Slow
European markets appear to be more
adversely affected by the trade war and their own local economic issues.
Germany’s manufacturing sector, the engine of Europe dropped to its lowest
level since the GFC. The Bundesbank projected that the German economy has
entered a mild technical recession. The European Community reflected global
trends with the services sector remaining in mild expansion but the
manufacturing sector contracting.
Summary
We continue to be cautious in our
outlook. In isolation events such as US Presidential impeachment proceedings
are unlikely to be overly disruptive, but the weight of factors combined
requires ongoing vigilance. In the fixed interest market sentiment remains for
low rates to prevail. Potentially short-term rates in New Zealand will likely
continue to decline but some steepening of the yield curve could occur as
short-term rates fall further, and longer-term rates do not decline to the same
extent. The market currently prices an aggressive reduction in the OCR over the
next year of a further 0.40%. That said the possibility of negative rates has
diminished over the last month. RBNZ Governor Orr in his most recent speech
stated “…in our current view we are unlikely to need unconventional monetary
policy tools.” Similarly, global interest rates appear likely to continue to
moderately decline/remain with current trading ranges. In an absolute sense
interest rates have limited scope to decline further. While the tail winds for
the fixed interest rate markets are dissipating there appears minimal risk that
rates will lift materially in the near term.
Although economies are slowing, they
are not in recession. Within stock markets non-cyclical growth at reasonable price
is becoming more difficult to identify. However, earnings yields remain
positive and equity values are supported by interest rates. Given the
differential in yields between fixed interest and shares is likely to persist,
the relative attractiveness of shares is preserved.
Globally, the Fed and US-China trade relations continue to take centre stage in the economic theatre of 2018 (so far a drama not a tragedy) while Brexit and Italy present challenges to the European outlook.
US / China Trade
In a much-anticipated working dinner in Buenos Aires following the G20 summit, Mr Trump and Mr Xi agreed to a temporary ceasefire, in which the US president suspended his decision to impose higher tariffs, from 10% to 25% on $200bn on Chinese imports until March 1st, 2019 at the earliest. In exchange, China will increase its purchase of American farm produce, energy and some industrial goods. However the truce is fragile and formal talks between the two countries could well fail due to the high hurdles that stand in the way of agreement. First, the Chinese commitment to raise purchases of American goods is by an amount “not yet agreed upon, but very substantial” is unlikely to reduce America’s bilateral trade deficit with China by a significant amount. Second, the challenge that negotiators now have 90 days to agree “structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture” is ambitious, particularly when levels of trust between the two sides are so low. It is evident that this theme will continue into 2019.
China
China’s recent slowdown in gross domestic product growth is unsettling global markets and testing the Communist party leadership. Beijing is determined to keep its economy stable but doing so means tackling the politically sensitive issue of its private sector. Private enterprises are China’s economic mainstay, contributing about two-thirds of output and investment and the lion’s share of jobs. They drive the prosperity upon which the Communist party’s legitimacy rests. Yet Mr Xi has favoured state-owned firms since he took power in 2012 and clipped the wings of several high-flying private entrepreneurs. Now, as Beijing seeks to stiffen its resolve in the US-China trade war, the private sector’s dynamism is flagging, creating economic headwinds. Third-quarter GDP growth slipped to 6.5 per cent, year on year, its slowest since 2009. While this is by no means lacklustre, there are signs momentum could slackenfurther.
We expect flexible policy to come from Beijing as it attempts to manage headwinds associated with trade disputes, slowing demand and negative sentiment toward its equity markets causing investment outflows. China has accounted for 36% of global GDP growth since 2010 and has played a vital role in the economic recovery. This too will be a key focus for the global economic outlook in 2019.
Brexit
Political uncertainty in the UK is extreme currently and reflected in investor positioning in sterling and UK equities.
Theresa May is battling to save her Brexit deal and her own position as Prime Minister after a series of ministerial resignations and the threat of a Eurosceptic coup left the Conservative party on the brink of civil war. Mrs May insisted she would stick to her plan, which would keep Britain closely tied economically to the EU, and said she was not about to quit in spite of growing criticism from Brexiters in her own party. Mrs May warned that Britain would embark on “a path of deep and grave uncertainty” if it abandoned the withdrawal deal it had agreed with the EU.
It’s unclear whether the refusal of May’s deal by British parliament would turn into a ‘hard’ Brexit (i.e. with no deal). The crucial vote in Parliament is on December 11th. May said there was no plan B, however, some commentators suggest that the transition period may get extended again due to the complexities of reaching a deal. The more it is extended, the closer it gets to the June 2022 election, increasing the likelihood of a potential second referendum.
Britain’s Treasury estimated that GDP will be 3.9% smaller in 15 years’ time than it would otherwise have been if the country leaves the European Union under the deal recently agreed with EU leaders. Under a no-deal Brexit, it would be 9.3% smaller.
US
The Fed’s tightening path had fuelled fears about a sharp downturn in the US housing sector. Home sales have slowed, inventories are rising, and homebuilder equities have sold off over 30% YTD.
However, the recent market reaction to a statement from the Federal Reserve Chairman Jerome Powell that we are approaching neutral shows how critical investors see this current period of tightening. Sharemarkets rallied as Jerome Powell said he sees current interest rates “just below” neutral. That proved to be significant because the language Mr. Powell used 6 weeks earlier indicated a view that the fed funds rate was “a long way from neutral.” Powell added that there is no pre-set policy path, and the Fed will be data-dependent in its decision making, which pleased investors. By highlighting risks, though, that included previous rate increases, trade disputes, and Brexit/EU political uncertainty, the market chose to read between the lines that the Fed chair isn’t wedded to three rate hikes in 2019.
The results for the recent US midterm elections were widely predicted (which is a surprise by itself). Democrats took the House of Representatives which will provide some oversight of the White House when members of the new Congress take their seats in January. Republicans held the Senate—with a bigger majority, which will make presidential appointments easier to confirm. Both sides declared victory. A starkly divided country now has a divided government. Underpinning the results, though, is the deepening of a structural shift in American politics that will make the country harder to govern for the foreseeable future.
Europe
The fate of the euro strongly depends on Italy. With annual GDP of more than €1.6trn ($1.9trn), about 15% of euro-area output and debt of nearly €2.3trn, it poses a challenge to the single currency that Europe seems unable to manage but cannot avoid. Matters are now coming to a head, as Italy’s new coalition government instigates a showdown over the European Union’s fiscal rules. The disagreement might well become disastrous. But it is also an opportunity for the euro zone to begin building a better, more durable approach to fiscal policy.
Trouble began earlier this year when the populist Five Star movement, led by Luigi Di Maio, formed a government with the right-wing Northern League, led by Matteo Salvini. Both promised budget goodies: Mr Salvini a hefty tax cut and Mr Di Maio a basic minimum income. Such a bounty may test the deficit limit of 3% of GDP set by the EU’s stability and growth pact and it seems certain to break other fiscal rules set by the bloc: the government’s initial budget plan is forecast to raise borrowing to 2.4% of GDP in 2019, above the 0.8% target to which Italy previously committed itself and enough to reverse recent, modest declines in its debt burden.
The EU did not take the news well. On November 5th other countries’ finance ministers warned that failure to revise the budget would lead to an “excessive deficit procedure” and possible sanctions.
Australia
We expect real GDP growth of around 3% by end-2018. Such a pace of growth should see the unemployment rate largely track sideways over 2018. Household incomes and consumption growth remain weak, possibly due to a weaker housing market, particularly in Sydney and Melbourne.
New Zealand
While actual economic output continues to grow a persistent downturn in business sentiment has emerged. The ANZ business outlook survey reported that headline business confidence remained stubbornly low, with a net 37% of respondents reporting they expect general business conditions to deteriorate in the year ahead. The likely explanation for which confidence is being rocked is a combination of policy uncertainty, capacity restrictions and margin pressure.
Labour market conditions have now tightened to a point where we expect wages to (finally) begin to move higher. However the RBNZ took an unexpectedly dovish turn in the August MPS, despite expecting modestly higher inflation in the near-term, and it has reiterated this approach recently.
Summary
For New Zealand, our economy has been supported by the tailwinds of record-high Terms of Trade, low interest rates and strong population growth. Nonetheless, business confidence remains weak and points to an upcoming slowdown in growth led by a fall in business investment.
Globally the combination of strong growth and loose financial conditions was highly supportive for equities in 2017. This year we have seen a tightening of financial conditions alongside a divergence of global growth, with the US outperforming. In 2019, we see renewed economic convergence driven mainly by the US economy slowing at a time when inflation pressures and interest rates are increasing. We do not see a recession as likely in 2019. Without a recession, it is unlikely that profits fall. Without profits falling, it is unlikely that we see a sustained equity bear market.
There has been a cyclical increase in global economic activity over the past couple of years, but we believe the longer-term outlook for economic growth remains subdued with risks to the downside because of structural headwinds. The US – China trade talk news will underpin investor sentiment in the short term. In 2019, investors should ensure that their portfolios have a risk exposure consistent with their risk tolerance.
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Information and Disclaimer:
Source:JMI (previously JMIS), the investment consultant to the Select Wealth Management service.
This report is for information purposes only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should contact Miles Flower on 021 645 000.
The near-term outlook for the world economy is still positive, however, mounting tensions over a potential US-China trade war suggests an elevated risk to the medium term outlook. We expect events in early July will likely be the key to understand the effect of this potential trade war, as the US is poised to impose the first significant tariffs at that time.
In the US, strong economic growth and low unemployment will likely prompt the Fed to raise rates two more times this year while, in the euro-zone, the ECB is on track to end its asset purchases by December. Any trouble in emerging markets could be largely confined to Argentina and Turkey.
Global
While world trade has softened in recent months, the stability in trade volumes recent months offers some reassurance. Although the protectionist measures and rhetoric have escalated in recent weeks, the consequences do not yet point to anything worse than a modest slowdown of a resilient global economy, supported partly by household spending expanding at a decent pace. Further ahead, however, with monetary tightening set to take a toll on the US economy next year and China losing some momentum, global growth is predicted to slow in 2019 and 2020. This assumes no catalyst. such as a severe trade war, eventuates prior to then.
The US
GDP growth should rebound in the second quarter, helped by the fiscal stimulus of recent tax cuts. This should keep pressure on the Fed to continue gradually hiking interest rates. Markets anticipate a total of four hikes this year and another two in the first half of 2019. As the stimulus fades and the cumulative monetary tightening bites, however, a slowdown in GDP growth could eventually force the Fed to reverse course by cutting rates around 2020.
In June, the Federal Reserve lifted its benchmark interest rate by a quarter of a percentage point, to a range of between 1.75% and 2%, the second rise this year. The last time the rate reached 2% was mid-2008, before the worst of the financial crisis. The Fed hinted at two more rises this year and dropped its statement that monetary policy would remain stimulative for some time.
The UK
The UK’s Monetary Policy Committee (MPC) is unlikely to wait too much longer before adopting more hawkish measures and increasing interest rates. Although the beneficial effects on exports of the pound’s fall may be fading, it is not clear that the sterling boost to growth is over. With sustained rises in real wages anticipated, real
GDP is likely to rise by around 1.5% to 2% over 2018/19. This should allow the MPC to raise interest rates at a faster pace than markets expect. Indeed, the Committee could hike rates in August, and by a further three times by the end of 2019.
Europe
The ECB recently announced its plans to end asset purchases this year, but it also clearly outlined that it is in no rush to raise interest rates. Investors’ expectations have now shifted to the view that the expansionary policy is set to continue and that the ECB will wait until late 2019 before raising interest rates.
The Italian financial markets are likely to remain under pressure in the coming months due to concerns about the new government.
Emerging Markets
The growing threat of a US-China trade war and a strong US dollar
are the key risks to emerging markets. Even if trade tensions don’t worsen, GDP growth in Emerging Asia has peaked and is likely to ease over the coming year. Central banks in Indonesia, Korea and the Philippines are likely to raise rates further before the end of the year, but other central banks in the region will be in no rush to follow.
Regional growth is likely to slow over the course of 2018-19 in Emerging Europe. The sharpest slowdown will come in Turkey, where the recent tightening of financial conditions will feed into weaker economic activity. Meanwhile, Argentina’s recently agreed IMF deal imposes an aggressive tightening of fiscal policy, which could push the economy into recession.
Australia
Although GDP remains strong, the end of the mining, housing and migration“booms” has softened the outlook for the economy and the financialmarkets. The result is that interest rates are unlikely to rise soon and the Australian dollar could weaken in response to rising US rates. There is a risk that tightening credit controls in response to the Royal Commission into Banking may conspire to weaken Australian housing.
The escalating trade spat between the US and China could potentially boost the Australian economy in the near-term, but any reduction in global trade would be bad news for Australia in the long-term.
Governor Lowe outlined in a speech in late June that, before interest rates are raised from their record low of 1.5%, the RBA will want to have“reasonable confidence that inflation is picking up to be consistent with themedium-term target and that slack in the labour market is lessening”. Weexpect rates to remain on hold until at least the second half of 2019.
In June, the AUD depreciated against the USD by -2.15%.
New Zealand
At home. the Reserve Bank of New Zealand left interest rates on hold at 1.75% in late June. Governor Orr repeated that the OCR will stay at the current expansionary level for a considerable period. Comparing this with the federal funds rate, which pushed higher in June to a target range of 1.75 to 2%, it is the first time since late 2000 that the OCR is lower than the Fed funding rate. In June, the NZD depreciated against the USD by -3.33%.
Summary
Global markets continue to face a more balanced set of tailwinds and headwinds than was the case a year ago. While the economic and earnings outlook remains relatively strong, the peaking of leading economic indicators and earnings revisions suggest a more challenging environment as momentum for both slows.
Monetary policy generally remains accommodative and the expectations are for future policy direction to be neutral at best, but more restrictive in the US with multiple rate hikes planned over the balance of 2018. We expect events in July are likely to be key to understand the extent of the impact of the US-China trade negotiations as the first significant tariffs are implemented. We will continue to monitor these events carefully to consider investment risk.
Also, geopolitical risks such as the instability in Italy endangering eurozone stability and the overhang of Brexit negotiations will be important to watch too.
Given the extended period of strength from investment markets, it is important that the risk levels in clients’ portfolios are appropriate.
Potential trade wars and interest rates have dominated the news in March. The first quarter of 2018 continues to show signs of more volatility and nervousness in markets particularly as the US, being furthest of the advanced economies through its cyclical growth, presents a different economic narrative to the rest of the world. Fundamental indicators of economic growth still suggest advanced economies are continuing to grow and stay strong, albeit against a backdrop of political risks surrounding the US’s move toward protectionist trade policies.
US
The Fed’s decision to raise interest rates in March by 0.25% was widely expected but some have been caught off-guard by the degree to which Fed officials increased their projections for future interest rate hikes. The median forecast for the Fed funds rate at the end of 2019 is now 2.75-3.00%, which until recently was at the hawkish end of the spectrum.
The direct economic impact of the tariffs which have been announced by the Trump administration are unlikely to be significant, and even if they are implemented in full, we suspect that any retaliation will be moderate. Businesses in the US are generally united against the tariffs, and Chinese retaliation would fall hardest on the ‘Farm Belt’ States that helped Trump win in 2016 and heavily rely on the export of soy bean to China. In that event, a trade war may be bad politics as well as bad economics. But the protectionist announcements and actions continue to weigh on investor sentiment as it is unclear that a moderated rational approach will win out in trade negotiations.
With the benefits of the fiscal stimulus, strong global demand and the weaker dollar, the Fed officials raised their forecasts for economic growth, with the median rising to 2.7% this year (from 2.5%) and 2.4% in 2019 (from 2.1%) which we consider slightly optimistic. As the fiscal stimulus begins to wear off and the cumulative monetary tightening starts to bite, GDP growth could slow in the second half of 2019.
China
The tariffs on Chinese imports outlined by President Trump are unlikely to have a big impact on the Chinese economy directly, and we think that the measures will end up being watered down. But as the recent market reaction highlights, there is a clear risk that investor sentiment continues to deteriorate and the damage from a further escalation of the trade conflict with China could be much greater.
In monetary policy, Chinese authorities are cutting the amount of cash local banks are required to set aside to cover bad loans, a move that would boost lenders’ bottom lines but potentially increase financial risk. With the sector struggling to boost profits, the country’s banking regulator will lower the provision coverage ratio for commercial banks—a requirement to safeguard their ability to weather losses—to a range of 120%-150%, from the current minimum of 150% of their bad loans. It is likely that the recent 5bp rate hike by the People’s Bank of China will not prevent market interest rates in China from continuing to fall, as they have done since the last rate hike in December.
Europe
The Euro-Zone should continue its expansion while allowing the European Central Bank (ECB) to wind-down its asset purchases this year, which would mark an end to a period of quantitative easing dating back to the financial crisis. We see it as unlikely that ECB will follow the US and raise interest rates anytime soon.
It is also likely that Europe will exercise restraint when considering retaliatory measures in the face of higher steel and aluminium tariffs, regardless of whether it is granted permanent exemptions, as its interests are to minimise the risk of trade conflict.
In the UK, news that an agreement has been reached on a transition period after the UK formally leaves the EU reduces the risk of a Brexit-related downturn. There is also mounting evidence of higher wage pressures, with average earnings growth at 2.8% in January and suggests that the Bank of England will be sooner, and more likely, to follow the US on interest rates.
Australia
In mid-March, the Reserve Bank of Australia (RBA) left interest rates on hold at 1.5% for the 17th consecutive meeting and it noted once again that progress in returning inflation to target is likely to be “gradual”, suggesting that a near-term rate hike remains unlikely.
Further ahead, we expect that interest rates will remain on hold until the second half of 2019. Aside from an acknowledgement that “market volatility has increased from the very low levels of last year”, the new policy statement wasn’t much changed from February’s statement. Indeed, the RBA retained its fairly optimistic view on the outlook for economic growth, saying that it expects the economy to “grow faster in 2018 than it did in 2017”.
The unemployment rate may need to fall from 5.5% currently to around 4.0% before wage growth rises significantly. This is partly due to the existing excess capacity not captured by the unemployment rate, but also as the natural rate of unemployment may be notably lower than most estimates of 5.0%.
The economy will probably cope reasonably well even though both the mining and housing booms are over, but over the next couple of years it is unlikely to strengthen as much as policymakers hope.
New Zealand
The Reserve Bank of New Zealand Governor Grant Spencer finished his six-month term leaving interest rates at 1.75% for the 16th consecutive month and reiterating that rates are unlikely to rise until the second half of 2020 The new Governor Adrian Orr is unlikely to begin with a bang when he takes over on Tuesday, not least because he will have to deal with a slowing economy and not enough inflation, but we can’t completely dismiss the possibility that he shakes things up a little.
The 2017 fourth quarter GDP report showed a healthy expansion with the RBNZ expected figures growing 0.7% and the trend appears to be in line with expectations and unaffected by an election transition. Weather extremes are likely to affect farming outputs however other well performing areas such as retail and services have contributed to the growth in the economy.
NZ’s underlying economic momentum should continue with the current trajectory of domestic demand growth that will continue to put pressure on capacity constraints and inflation wages over the course of 2018. There is a potential small divergence in business confidence as compared to Australia this year, some explanations suggest that it could be linked to uncertainty surrounding the policies of the new government in NZ. Best estimates are that GDP growth in Australia will accelerate from 2.3% last year to 2.5% this year while growth in New Zealand will probably hold steady close to 3.0% or perhaps drop slightly.
Summary
Global macroeconomic indicators still point to a global growth story despite markets becoming increasing cautious and volatile. The first rise in interest rates in the US suggests that inflation is around the corner. US protectionist policies are likely to affect market sentiment more than the fundamentals of economies.
Given the length of the economic recovery and period of strength from investment markets, it is important that clients’ portfolios are no more growth orientated than their long term strategic asset allocations.
___________
Information and Disclaimer:
Source:JMIS Limited, the investment consultant to the Select Wealth Management service.
This report is for information purposes only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should contact Miles Flower on 021 645 000.
Aside from the February turbulence in equity markets, global economic growth should hold up well and inflation should remain low in 2018.
The recent hard economic data and survey evidence suggest that the world economy is growing at a rate over 3% pa and there is enough spare capacity in many economies for the expansion to continue for a while yet.
Meanwhile, although central bankers are reducing their policy support for this growth, they are doing so only gradually because inflation generally remains low. One explanation for the recent slump in equity and bond prices is that investors have become concerned that inflation is about to take off, forcing central bankers to tighten policy more rapidly than previously expected. However, underlying inflation has remained low and stable, even in economies which are closest to full employment.
US
Non-farm payrolls increased by 200,000 in January, following an upwardly revised 160,000 in December, and beating market expectations of 180,000. The share market reacted sharply downwards at the beginning of February to this strong number accompanied by private sector hourly wages increasing from +2.5% to +2.9%. This very good fundamental economic news was interpreted negatively in the context of a rising risk for inflation, and therefore interest rates. In fact, the jump to 2.9% year-on-year in January, which triggered the market sell-off, was exacerbated by temporary weather patterns and may yet be reversed.
The surge in the Conference Board’s consumer confidence measure to a 17-year high of 130.8 in February, from 124.3, underlines that household sentiment has not been knocked by the recent bout of stock market volatility. Instead, it has continued to strengthen, as households begin to see the recently passed tax cuts show up in their pay cheques. We expect the Fed to raise rates a total of three or four times this year, beginning with a 0.25% rise in interest rates in March.
China
China’s January CPI inflation moderated to 1.5% year-on-year and PPI inflation decelerated further to 4.3% year-on-year. Exports growth inched up to 11.1% year-on-year in January, in line with consensus, and imports growth rebounded sharply to 36.9% year-on-year, partially on distortions of Chinese New Year holidays, significantly above consensus. China has recently proposed removing the two-term limit for the presidency, in a move that would pave the way for Xi Jinping to remain in office beyond 2023 and tighten his grip on power and the economy.\
Japan
Japan’s economy grew at a slower-than-expected 0.5% annual rate in the December 2017 quarter, as strong exports failed to fully compensate for relatively weak domestic demand. The preliminary data released in February showed that Japan has now managed eight straight quarters of growth, the longest expansion period since the financial bubble of the late 1980s. The unemployment rate is now at its lowest level since 1993, while January national core CPI (excluding fresh food) was +0.9% year-on-year, unchanged from December. Japan recorded a turn to trade deficit in January, of ¥943.4 bn, from a surplus in December. However, we note that this often occurs in January due to seasonality and this latest deficit was around 15% narrower than in January 2017.
Europe
Eurozone concerns over the continued weakness of the US dollar were laid bare in a recent set of European Central Bank minutes that highlighted fears that the Trump administration was deliberately trying to engage in currency wars. The account of the ECB’s January monetary policy meeting also revealed that its hawkish members pushed for a change in the bank’s communications, arguing economic conditions were now strong enough to drop a commitment to boost the quantitative easing programme in the event of a slowdown
Australia
In mid-February, the RBA reiterated its forecasts for a more positive growth outlook in Australia and a gradual pick-up in wages and inflation. Even so, key uncertainties remain with regards to the amount of spare capacity in the economy, the speed of recovery in wages and the outlook for household consumption. The RBA will almost certainly leave interest rates on hold at 1.5% at its policy meeting in March and it will probably continue to signal that there is no risk of a near-term rate hike. Indeed, as progress in raising inflation to the 2-3% inflation target is likely to be slow, rates will probably remain on hold throughout 2018 and the first half of 2019 too.
New Zealand
If global equity markets are fearing higher interest rates, as this month’s fall suggest, then Australia and New Zealand offer something of an oasis as both the RBA and the RBNZ have recently dropped some heavy hints that they are in no rush to raise interest rates. This does not mean Australian and New Zealand equity markets are immune to any further global weakness, but it may mean that their bond yields do not rise as far as elsewhere; as well, their currencies may weaken.
Summary
While the sudden increase in market volatility in February raises concerns, we do not believe that the bull market in equities has yet come to an end. The underlying fundamentals of the global economy remain very strong. The synchronised global growth currently underway is the best level of economic activity seen this century. Strong global growth is contributing to the strong upward revisions to forward revenues and earnings for companies around the world.
While core inflation is still contained in much of the world, the continued strength in the labour market in the US has heightened fears that wage inflation there is finally taking root. With the US Fed already on a tightening path and with three to four further rate hikes priced in this year, the market has become concerned about the impact of higher long-term rates on equity valuations.
Higher bond rates reflect a stronger global economy and are typical during the latter stages of an economic expansion. Historically, this is also a period when equity returns can be very strong.
A diversified approach to portfolio construction remains appropriate.
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Information and Disclaimer:
Source:JMIS Limited, the investment consultant to the Select Wealth Management service.
This report is for information purposes only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should contact Miles Flower on 021 645 000.
