Economic Update – February 2019
Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.
Markets roar back to life!
– Federal Reserve clarifies its position
– China data were weaker than expected
– Australian rate cuts on the horizon
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
We reported last month that we had the Australian and US stocks markets as being meaningfully under-valued. Well they are much less so now after a very strong rally during January.
The turn-around in markets started straight after Christmas and gained momentum throughout January as the US Federal Reserve (“The Fed”) made increasingly dovish tones – so much so that the chance of a rate hike this year is now estimated by the market to be minimal. A chance of a cut this year now has gained some support among the analyst community.
The end of January Fed meeting produced a no-change result on rates and the chairman emphasised the word “patience” in his press conference about the timing of future moves. The accent is once again firmly on “data driven” policy changes rather than following a pre-set course.
The US-China trade stoush took a few more twists and turns. The threat of more tariff increases looms large but could well be averted. The China economy is clearly in need of avoiding that situation and so some solution may come soon. China did offer to reduce the trade balance with the US to zero over the next 6 years, however, more needs to be done to address what is characterised as the rampant abuse of intellectual property rights.
US employment data series were particularly strong. A much bigger than expected 312,000 new jobs were created. Unemployment came in at 3.9% pa and, importantly, wage growth was a far more respectable 3.2% pa. The weakness in the US economy mooted by some does not seem to be showing through in the data – at least not yet.
China inflation data – both consumer and producer variants – came in weaker than expected. GDP growth was 6.6% for the year – which was on expectations – but import and export data were weaker.
The weakness in China data is nowhere near as bad as some are making out. There is a natural progression from the double-digit growth of a decade ago to more moderate levels as any country matures. The Chinese government is putting in place policies to combat any slowdown so we do not see modest softness in GDP growth becoming a problem unless Trump brings the next round of tariff hikes into play.
At home, the biggest change has been the attitude towards possible rate cuts by the RBA. This was almost unheard of a month or so ago but the muttering has become louder. Indeed, one leading analyst reported a 36% chance of a rate cut this year.
One reason for a cut is that the NAB and ING just finished the out-of-cycle home loan rate increases. The second is that our CPI inflation data has been persistently lower than the target band of 2% to 3%. The latest reading was 1.8% making it 15 out of the last 17 quarters that the rate has been below the target range.
The RBA has a dual mandate. First it must try and keep full employment. At the current 5% that could be said to be have been fulfilled as there is no prescribed number. The second is to keep inflation within the target band. The RBA has failed in that regard – even in any ‘average over the cycle’ sense.
Our employment data was quite strong again this month but, as always, our immigration numbers helps underpin that and more generally economic growth.
In short, the US Fed has learnt its lessons from making last October’s ill-advised comments. If Trump can be a little more compliant, the US does not seem to be an issue – and neither then would China. And if/when we get a rate cut (or two) from the RBA, we’ll be doing better too. We reiterate our view that Australian and US stock markets barring any unforeseen events are forecast to have an average year of returns in 2019 – with the balance of risk to the upside.
The ASX 200 put in a strong month in January at +3.9% with Energy stocks (+11.5%) leading the way. However, the Financials sector, under the weight of the Royal Commission, produced a capital loss of 0.2%.
We have the index only slightly under-priced at this point but our forecast of capital gains for the next 12 months has risen slightly as the February reporting season approaches. Brokers have been modestly increasing their earnings forecasts.
We do not see a return to the 2018 peak through the forecast period but all being well it is not out of the question that we could see it by the end of the year.
All the major indexes put in a strong January with Wall Street’s S&P 500 gaining +7.9%. Even Emerging Markets put in over 6%.
In contrast to the ASX 200, we have the S&P 500 sufficiently under-priced to continue the January rally for a little while longer.
Our 12-month capital gains forecasts for the S&P 500 (based on broker forecasts of earnings and dividends) did start to slip a little into the end of 2018 as a pall of gloom started to collect over Wall Street. However, the Q4 reporting season, which is still underway, has given brokers the confidence to reverse some of those calls. As a result, our index forecast strengthened a little – and has stabilised.
Bonds and Interest Rates
The Fed has started 2019 on a clear path to maintain patience over any rate changes and that has pleased markets. A reasonable chance of a cut this year is now being priced in however important to note that any rate adjustment will be data dependent. But noteworthy that the attitude of the US Fed has softened somewhat and they now look to economic data to guide rate policy.
There is now also a significantly greater chance of a rate cut this year in Australia. Such a cut would act to offset the big four banks out of cycle rate hikes of recent times and possibly help promote inflation into the 2% to 3% band.
The prices of iron ore and oil surged by more than 15% each in January. Those increases helped support the January rallies in resources stocks.
Australia is inching towards its next general election and with the May budget looking like returning a small surplus both sides are offering sweeteners to the electorate. It is not clear that such expenditures are in the best interest of the economy’s long-run growth path.
There were 21,600 new jobs reported in the last Labour Force Survey which is strong. However, all of these jobs and more were part-time. Full-time jobs shrank by 3,000.
If the RBA does cut the official cash rate soon, that could give a small boost to housing sentiment and the economy in general.
Interestingly, in the days before the Royal Commission hands down its findings, a new bank, Volt, has been given a full banking licence. With the increasing tendency towards internet-based payments systems, the big four’s customer base is at risk of being eroded over time.
We again emphasise that the economy is not ‘in trouble’. Rather, it is just not performing as it could. That said, we do not see a recession on the horizon in 2019.
China’s economy is rapidly approaching the size of that for the US – and the US is not happy about that. With economic size comes political power. It is, therefore, important that the global powers assist China in transitioning to the number one slot without upsetting world order.
Trump is trying to do his bit with trade policies. They may not be fashioned in the best way but it is a start to getting China to respect intellectual property rights and also behave in a way that fits in within a cohesive World Trade Organisation (WTO) type framework.
The near misses on the economic data front are not a major issue. It is not possible to guide any economy in a perfect trajectory. We see the Chinese government acting in appropriate ways over 2019 to ensure a stable outcome. That is, of course, unless Trump takes the tariff war too far.
The stand-off between Trump and the US Congress did not make any significant gains during January. The partial shutdown of the US government is due to switch back in quite soon and the debt ceiling debate will loom large in about six months.
Whatever we think about the US political process, the hard-economic data are quite good. GDP growth has been strong and jobs growth has been even better.
It is not possible to predict what Trump will do next but he does not have a free hand – especially with this new split Congress. Some compromise on the ‘wall’, and a ‘fig leaf’ from China on trade could have a big positive impact on economic prospects for 2019.
Companies reporting quarter four 2018 earnings at the moment have been a little mixed but there have been lots of very strong results – hence the positive stock market reaction.
The Brexit issue rolls on and on. It now seems quite likely that, in effect, the March 29, 2019 deadline for the Brexit might be pushed back until later in the year.
The German economy has spluttered a bit in recent months. German car manufacturers are suffering from the US trade tariffs but the impact on Australia is muted.