April 2016 Market Update

It’s been a busy week in Australia with the Turnbull led Government calling the non-surprise Double Dissolution Federal election (who else received the postal vote application form the next day via ‘miracle post’?). The election has been called for July 2nd. While there may be some uncertainty about global and even Australian economic prospects, the future track of Australian interest rates has become clearer. The May Reserve Bank of Australia (RBA) policy meeting along with the quarterly Monetary Policy Statement on Friday 6th of May settled a few issues about the outlook for interest rates which had previously divided economists.

The RBA confirmed that it remains focused on ‘inflation targeting’, even at a time when employment, economic growth and some interest sensitive sections of the economy, such as, housing activity, seem to indicate no need for change. The RBA’s inflation forecast has been tracking ‘surprisingly’ low for some or simply ‘low’ when you consider the deflation fight in Japan and Europe.

The Federal Government’s Budget and the Oppositions budgetary response appear to achieve similar net government spending over the coming year’s all-be-it with very different priorities. It seems that neither the Government nor the Opposition will boost net spending as a portion of Gross Domestic Product (GDP). With Moody’s rating agency already firing the first shot across the fiscal bow, neither party wants to risk a rise in government debt that might precipitate a downgrade to Australia’s AAA sovereign credit rating. This neutral contribution to growth leaves the RBA in position of swing policy mover when anything changes to the outlook for growth and inflation.

Moving back to April……. Some of the factors that sparked the first quarter market swoon have gone into hiatus: oil prices have increased, the Federal Open Market Committee (FOMC) has taken a more dovish tone and Chinese economic data points have improved. China’s March economic readings were almost all stronger than expected and improving commodity prices, notably the iron ore price (which as I write tonight has tumbled), added to a sense that China’s economic growth rate may be starting to improve. For Australia, economic readings relating to February were mixed, but consistent with moderate GDP growth. The RBA will be continue with its easing bias should demand in the economy shows signs of weakening.

In the US, economic readings for April showed comparatively soft GDP growth in the first quarter as well as some easing in inflation. Almost all housing indicators took a weaker turn although existing home sales increased from the previous month. Retail sales were down by 0.3% month-on-month and industrial production fell 0.6% month-on- month for a second consecutive month. Despite this, the labour market improved in February. While the unemployment rate rose slightly to 5% the US economy continues to generate 200,000 additional jobs each month.

Economic readings in Europe remain consistent with annual GDP running at 1%. The European Central Bank (ECB) left monetary policy setting unchanged in April. The ECB is cleat about having more policy tools at its disposal, negating some concern surrounding negative interest rates. The two biggest concerns in Europe are high unemployment and price deflation. Both are moderating, all-be-it very slowly, leaving Europe’s economy vulnerable to a setback.

In Australia, February readings were disappointingly weak; retail sales recorded 0% growth month-on-month and we had a much wider trade deficit of $3.4b. Housing however showed improvement. Employment was up and unemployment fell 0.1% to 5.7%. The biggest drag on the Australian economy continues to be the rundown in mining investment spending which shows of sign of abating. While the RBA maintains an upbeat view of Australian economic prospects, they have also made it clear that a strong Australian dollar is unhelpful in rebalancing the economy to non-resources sectors.

Our view is that Australia’s growth rate could be skewed to the downside and the that the RBA could cut rates further to offset rising lending rates and an appreciating Australian dollar. We doubt that the current bull phase for stocks, corporate bonds and commodities will have legs beyond the near-term bounce. Our sense is that the current reflation trade may extend into August, before going into reverse. The Bank of Japan and ECB are likely to continue to push the boundaries of monetary policy with the much talked about ‘helicopter drop’. This is likely to cause the US dollar to rise, further undermining commodity prices and emerging markets. High price earnings ratios (PE) continue to be a risk and vulnerable to market shakeouts.

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Sources: Alexander Funds Management, BCA Research
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