Investment Update – May/June 2016

by Miles Flower | Jun 1, 2016 | Investment News, Uncategorised

The International Monetary Fund (IMF) has warned that the recent period of slow growth has now left the global economy more exposed to negative shocks and raised the risk that the world could slide into stagnation.

In April, the IMF cut its world expansion forecast, as weak exports and slowing investment dim prospects in the US, a consumption-tax hike saps growth in Japan and a slump in the price of everything from oil to wheat continues to hobble commodities producers.

The IMF estimates that the world economy will grow 3.2% this year, down from a projected 3.4% in January. The IMF cited among the biggest risks as a “return of financial turmoil itself, impairing confidence and demand in a self-confirming negative feedback loop.”

There was one bright spot: the IMF upgraded its China growth forecasts by 0.2% for this year and next, following signs of “resilient domestic demand” and growth in services that offset weakness in manufacturing.

US

 In a widely expected move, the Federal Reserve left interest rates in the US unchanged in late April. The virtuous cycle of solid jobs growth and robust consumer spending will continue to sustain economic growth at a pace consistent with ongoing tightening in the labour market.  The market still expects two 0.25% interest rate increases from the Federal Reserve in the second half of 2016.

The US Federal Reserve’s Beige Book—an anecdotal summary of economic conditions compiled by the regional Reserve Banks— reported in April that activity continued to expand across most of the country in late February and March 2016. Consumer spending once again increased in the majority of Districts.  The description of manufacturing activity was upgraded, in line with the improvement seen in most manufacturing surveys in March.  Labour market conditions continued to strengthen and several Districts reported signs of a pickup in wage growth.  Retail prices increased modestly across the majority of districts, while input cost pressures continued to decline.

GDP grew at a rate of 0.5% for the first quarter of 2016 versus a median forecast of 0.7%.   Unemployment remains at 4.9%.

Japan

 While the latest IMF growth forecasts for the US and euro area were marked down by 0.2%, the deepest reductions in advanced economies made by the IMF came for Japan. The Bank of Japan (BOJ) currently has its benchmark interest rate at -0.1% and continues to defend negative interest rates as a useful tool against inflation as well as a tool to encourage economic growth.

In late April, the BOJ dashed market hopes by keeping monetary policy on hold. Its decision to keep monetary policy unchanged came despite inflation data showing a slide into year-on-year deflation for the first time since 2013. The decision gambles that Japanese business confidence will hold up, despite the stronger yen, and a recovering US economy will come to Japan’s rescue.

China

China’s economy grew 6.7% in the first quarter, its slowest quarterly expansion in 7 years but within the government’s target range of 6.5% – 7%.

China’s monetary and fiscal stimuli to date have yet to spur a rebound in the world’s second largest economy.   In March, nearly all the usual economic indicators remained at levels signalling deterioration, although the pace of declines is moderating.

There was one positive and strong exception: China’s exports rebounded in March and declines in imports narrowed on recovering commodity prices, leaving a trade surplus of 194.6 billion yuan and adding some further evidence of stabilization in the world’s second-biggest economy.

 The ECB bank kept its benchmark interest rate at zero in April.  It said that the ECB stands ready to use “all instruments available”, including further cuts in all its interest rates, to ensure the inflation rate returns to its target.  ECB President Mario Draghi warned that challenges to his central bank’s independence by the likes of Germany would dent confidence in the euro zone’s recovery and force policymakers to keep rates lower for longer.  The ECB’s main interest rate is now at 0% and its deposit rate is – 0.4%, meaning banks pay to park excess funds with the central bank.

GDP grew in the March quarter by 0.6%, slightly better than expectations.

Australia

The recent economic data in Australia have been firmer.  Australia’s GDP rose 0.6% in the last quarter of 2015, well above most expectations. In 2015, the economy grew by 2.5%, down only marginally from 2.6% in 2014. The unemployment rate dropped to 5.7% in March.  As well, low petrol prices and supermarket wars are restraining inflation growth.

Indeed, against all expectations, first quarter inflation was a negative 0.2%, taking the annual rate to only 1.3% and, thus, reinforcing the case for more interest rate cuts soon.

Over-building and the flagging population growth is also squeezing growth in house rental costs.

However, there are a number of headwinds ahead, including excessive household debt and weaker demographics weighing on consumption growth and a corporate focus on distributions rather than capital spending, as mining investment has contracted sharply. Thus, more sluggish growth may well lie ahead, even as the outlook for China is now slowly improving.

New Zealand

In late April, the Reserve Bank left interest rates unchanged.

GDP growth this year should be around 2.3%pa, assisted by historic high net migration, rising construction sector activity, robust tourism growth and an expectation of a modest decline in the unemployment rate.  However, the likely absence of a sharp recovery in dairy auction prices points to a longer period of below break-even farm gate pay-outs and a continuation of challenging conditions going forward in the dairy sector.

The major risks to the outlook are assessed to arise from international developments, particularly a more pronounced than expected slowing in the Chinese economy and/or potentially a weaker-than-expected Australian economy.

The NZ economy retains a greater degree of both monetary and fiscal policy flexibility than a number of other developed market economies. A fall in the price of petrol saw inflation stay close to zero at the start of 2016. The official figures rose only 0.2% in the first three months of the year while, for the 12 months ended March 31, inflation rose by 0.4%.

Summary

Our current investment view is that the accommodative monetary policy settings in many jurisdictions around the world will continue to be supportive of global equity markets.

 However, we do believe that risks have increased.  Global growth outside of the US and China is very weak, the effectiveness of quantitative easing is coming into question as investors, companies and more generally economies are adjusting and become accustomed to the low inflation, low return world in which they are operating.

Accordingly, we are recommending to clients that their investment portfolios should be well aligned to their long-term strategic asset allocation positions and well diversified.

Investment Update – April 2016

by Miles Flower | Apr 28, 2016 | Investment News, Uncategorised

After a volatile start to 2016 in January and February, markets steadied somewhat by March and April as fears about a U.S. recession faded to the background and gains were made in oil, iron ore and other commodity prices. Major uncertainties that could lead to a renewed increase in financial market volatility are the growth outlook for China, the apparently dwindling market impact of monetary easing and the path of monetary tightening this year in the U.S.

US

In March, the US Federal Reserve (the Fed), as widely expected, held the Fed Funds target rate range unchanged at 0.25%-0.5%.  The Fed remains of the view that the economy will expand at a “moderate pace”, but has also highlighted the risks coming from “global economic and financial developments”.  While the Fed continues to expect the process of monetary policy normalisation to proceed in 2016, the Fed’s own forecasts now imply only two rate hikes this year – well down from the previous expectation of four moves.

Most recent economic statistics are still encouraging for the economy.  Nonfarm payroll employment increased by 215,000 in March (versus +205,000 consensus), a slight deceleration from an upwardly revised 245,000 in February.  The unemployment rate nudged higher to 5% on a higher participation rate and the employment gains were relatively broad-based, led by solid gains in service sector jobs (+199,000). Importantly, the average hourly earnings increased 0.3% from the previous month, taking the annual gain to 2.3%, slightly ahead of February’s 2.2% rise.

The ISM manufacturing index increased to 51.8 in March (versus consensus of 51.0), signalling the first outright expansion in the manufacturing sector since August 2015.

China

The central bank is increasingly finding itself in a bind, balancing its need to continue easing credit to support economic growth against its stated goal of keeping the Chinese currency stable.

In early March, the Central Bank announced that it would lower the Reserve Requirement Ratio (RRR) by 50 basis points for all financial institutions.  Large and small banks now hold 17% and 15% RRR, respectively.

This cut came after significant disappointment in trade data, which has been putting downward pressures on growth and equity market performance.

There is a broad consensus among private sector economists that the currency will fall further as China’s economy slows, but more doubt now about whether the Central Bank can control that process without imposing outright capital controls.

China’s 2016 National People’s Congress was held in Beijing in March.  China set a target range for 2016 real GDP growth of between 6.5% and 7.0% and it will pursue a more proactive fiscal policy, expanding its fiscal deficit ratio to 3.0% of GDP in 2016 from 2.3% in 2015.

Japan

In March, the Bank of Japan left its benchmark interest rate on hold at -0.1% and defended negative interest rates as a useful tool against deflation.

Europe

In late February, the European Central Bank (ECB) introduced a new financial easing package, cutting rates and expanding asset buying, but undid the very stimulus it hoped to achieve by suggesting there would be no further cuts. Seeking to resurrect corporate activity and investments, the ECB said it would start buying corporate debt and even offered to pay banks for lending to companies in the ailing euro area in a bid to kick start growth and stave off the threat of deflation.

Australia

In early April, the Reserve Bank of Australia left the cash rate at its record low of 2%.  Its statement read:

“Recent information suggests that the global economy is continuing to grow, though at a slightly lower pace than earlier expected. While several advanced economies have recorded improved growth over the past year, conditions have become more difficult for a number of emerging market economies. China’s growth rate has continued to moderate.

Commodity prices have generally increased a little recently, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Sentiment in financial markets has improved recently after a period of heightened volatility. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.

In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. Consistent with developments in the labour market, overall GDP growth picked up over 2015, despite the contraction in mining investment. The pace of lending to businesses has also picked up.

Inflation is quite low. Recent information has confirmed that growth in labour costs remains quite subdued. Given this, and with inflation also restrained elsewhere in the world, inflation in Australia is likely to remain low over the next year or two.

Given these conditions, it is appropriate for monetary policy to be accommodative.

Australia’s GDP rose 0.6% in the fourth quarter, well above most expectations. In 2015 as a whole, the economy grew by 2.5%, down only marginally from 2.6% in 2014.
New Zealand

In mid-March, Fonterra dropped its forecast payout from $4.15 to $3.90 per kilo of milk solids, after four of the last five dairy auctions saw falls in the price of milk.

Also, the Reserve Bank of New Zealand unexpectedly reduced the Official Cash Rate by 25 basis points to 2.25%. Its statement said:

“The outlook for global growth has deteriorated, due to weaker growth in China and other emerging markets, and slower growth in Europe. This is despite extraordinary monetary accommodation, and further declines in interest rates in several countries. Financial market volatility has increased, reflected in higher credit spreads. Commodity prices remain low.

Domestically, the dairy sector faces difficult challenges, but domestic growth is expected to be supported by strong inward migration, tourism, a pipeline of construction activity and accommodative monetary policy. The trade-weighted exchange rate is more than 4% higher than projected in December, and a decline would be appropriate given the weakness in export prices.

There are many risks to the outlook. Internationally, these are to the downside and relate to the prospects for global growth, particularly around China, and the outlook for global financial markets. The main domestic risks relate to weakness in the dairy sector, the decline in inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.

Headline inflation remains low. While long-run inflation expectations are well-anchored at 2%, there has been a material decline in a range of inflation expectations measures.  This is a concern because it increases the risk that the decline in expectations becomes self-fulfilling and subdues future inflation outcomes.

Headline inflation is expected to move higher over 2016, but take longer to reach the target range. Monetary policy will continue to be accommodative. Further policy easing may be required to ensure that future average inflation settles near the middle of the target range.”

Summary

Our current investment view is that the accommodative monetary policy settings in many jurisdictions around the world will continue to be supportive of global equity markets. While a sharp correction in equity markets occurred in January and February, we do not think that a bear market is imminent.  It will take signs that the global economy is actually in recession for investors to be unduly concerned.

However, we do believe that risks have increased.  Global growth outside of the US and China is very weak, the effectiveness of quantitative easing is coming into question as investors, companies and more generally economies are adjusting and become accustomed to the low inflation, low return world in which they are operating.   Moreover, we are now in the 7^th year of the bull market in shares.  Emerging markets are also under pressure from weaker commodity markets and falling currencies.

Accordingly, clients investment portfolios should be well aligned to their long-term strategic asset allocation positions and well diversified.  Should you require financial advice you should always speak to your Authorised Financial Adviser to take into account your investment needs or personal circumstances.

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Image Courtesy of Flickr: Nazir Amin https://www.flickr.com/photos/dodol/