March 2019 Economic Update – Glass Half Full

The global economy grew strongly in 2018, although there was a noticeable slowdown in the second half of the year. The pace of growth has continued to moderate in February.  Key indicators such as labour market conditions remain strong in the US and in Australia, providing hope that the current slowdown will be temporary. Central banks have moved to put monetary policy on hold which has spurred investment markets higher while investment markets also believe there will be a US/China trade deal.

In the US most leading indicators of activity released in February had softened, while remining strong and consistent with strong business and household spending. It is not yet clear how much of the slowdown in the US relates to the partial shutdown of Federal Govt agencies over funding of the Trump Wall. Growth is expected to slip further in the short term influenced by one off impacts of the government shut down and one of the worst winters in several decades.

While the near-term trend is lower growth the labour market is suggesting otherwise. US unemployment continues to tighten. Strong employment growth combined with increases in year on year real earnings point to resilient if not stronger household spending. Big employers like Amazon and Walmart have all increased their minimum pay to attract and retain employees.

Inflation is yet to breakout, so the US Fed has put monetary policy on hold and indicated a willingness to let inflation run above the target range for a while, ……when it gets there. This move is likely to be supported by soft economic data for now, so we expect US rates to remain on hold for a few months yet. This should provide support equity markets.

Judging by the recovery in the Chinese share market, there is increasing optimism that a potential trade agreement with the US will be reached soon. China’s much watched first foreign investment law is set to pass a vote on 15 March. This law will address some of the US’s trade demands. The law will establish the principle of equal treatment for both foreign and domestic investors and prohibit forced technology transfers.

GDP growth in China continues to moderate in the near-term, but if an agreement can be reached with the US on international trade the outlook for China’s growth prospects could improve. China has plenty of monetary and budgetary policy flexibility to reinforce the impact of any positive news relating to a trade agreement. Looking ahead, we expect the People’s Bank of China to cut the Required Reserve Ratio (RRR) as early as this month. Chinese GDP growth forecast is for 6.3%/yr for 2019. This will spur the economy but inflate old risks.

In Europe, the slowdown is more pronounced. Italy has slipped into recession with back-to-back negative quarterly GDP growth, not to mention Berlusconi’s latest girlfriend troubles. France is trying to deal with the ‘yellow vests’ protest and Germany’s growth was negligible. There are some pockets of strength in Spain and eastern Europe, but overall growth is weakening with downside risk from the closing stages of Brexit. The ECB maintained steady monetary policy settings at its first policy meeting in 2019, but the accompanying minutes indicate that it is becoming less confident that the current slowing in European economic growth is temporary.

Brexit remains at an impasse. However, it is possible that Theresa May has outmanoeuvred both British MP’s and the EU. May has recently gained some concessions from the Eu but not enough to convince her MP’s. The bargaining positions are changing, the looming March 28 deadline and more importantly the EU election on May 23-26. The EU elections could constitute a practical constraint on the EU and UK increasing the probability of a unity and cooperation required to get a deal done. EU officials are likely to oppose UK participation in the elections, the prospect of a disorderly UK exit is just as threatening, while in the UK, MPs are more likely to accept a deal that may not be optimal rather than being blamed for the alternative. Our view is that May will seek a short-term extension which will be accepted by the EU and allow time for further negotiations and concessions. UK parliament will consider the deal and after lots of jockeying will agree to it before the EU elections in which the UK will not participate.

In Australia it seems to be a similar story to the rest of the western developed economies. The labour market remains strong with unemployment falling and job vacancy at high levels with reports of skills shortages in some areas. There has been some pick-up in wages growth but not enough to move the inflation dial. On the flip side, other indicators showed slowing growth. The main uncertainty relates to the strength of household consumption in the context of weak growth in household income and falling house prices in Sydney and Melbourne. The savings ratio has been falling which is consistent with employment confidence. Inflation remains low but is expected to pick up over the next couple of years as the labour market tightens further.

The low level of interest rates in Australia and around the world continue to support growth. Increasingly tight labour markets will put gradual upward pressure on wages and inflation. Uncertainty in Australia will prevail for the short-term with a Federal election approaching in May. Our view is that there are increasing risks to the downside but that the RBA will hold rates for now with the next move up, there is no compelling argument for a rate cut.

Our global view can be summarised in 3 scenarios:

1. No material increases in inflation. Continue to muddle along.
2. Inflation emerges (particularly the US), the Fed is behind the curve and there is a material market correction as the Fed increases rates quickly.
3. Global economic slowdown. The severity of which would determine how markets react.

Any one of these scenarios are plausible. We will wait and see which way things will go but what we need to see is a resolution to Brexit (which could be imminent or drag on for another 2 years), resolution to US/China trade relations (we are less confident than markets) and strong government leadership that drives sound fiscal policy (we can still dream, right?).

Disclaimer:

This information was prepared by Royston Capital, ABN 98 158 028 392 AFSL 438262. The information in this presentation is current as at 18 March 2019 unless otherwise stated.

Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

This publication is confidential and intended only for current clients and prospective clients of Royston Capital and their professional institutional advisors only and is not to be provided to other persons.

This publication does not constitute an offer to sell, or the solicitation of an offer to buy, any securities or any interests in investment funds advised by, or the advisory services of, Royston Capital. This publication contains general information only and does not consider your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it.

No legal or tax advice is provided. Any taxation position described in this publication should be used as a guide only and is not tax advice. You should consult a registered tax agent for specific tax advice on your circumstances. Recipients should independently evaluate specific investments and trading strategies.

By accepting receipt of this publication, the recipient agrees not to distribute, offer or sell this presentation or copies of it and agrees not to make use of the publication other than for its own general information purposes.

The views expressed in this publication represent the opinions of the persons responsible for it as at its date and should not be construed as guarantees of performance with respect to any investment. Royston Capital has taken reasonable care to ensure that the information contained in this publication has been obtained from reliable sources, but no representation or warranty, express or implied, is provided in relation to the accuracy, completeness or reliability of such information. Royston Capital does not undertake and is under no obligation to update or keep current the information or content contained in this publication for future events.

Past performance is not necessarily indicative of future results.  In addition, the price and/or value of and income derived from any investment may vary because of changes in interest rates, foreign exchange rates, operational or financial conditions.  Investors may therefore get back less than originally invested.  Furthermore, these investments may not be eligible for sale in all jurisdictions or to certain categories of investors. Portfolio performance is based on a theoretical model portfolio, returns for individual investors may differ.

Royston Capital, nor its associates, does not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this publication.

© 2019 Royston Capital Pty Ltd.  All rights reserved.  No part of this publication may be reproduced by any means, whether graphically, electronically, mechanically or otherwise howsoever, including without limitation photocopying and recording on magnetic tape, or included in any information store and/or retrieval system without prior written permission of Royston Capital Pty Ltd.

Sources: Alexander Funds Management (Steven Roberts); Commbank Global Markets Research, RBA, Morningstar.