October 2018 Economic Update

Global economic growth continues to gather pace. Recent economic readings in advanced economies were mostly stronger, the US is starting to run into capacity constraints. The US-China trade war continues to ramp up, all-be-it in the lead up to US mid-term elections. Interest rates are rising and there is potential for an emerging markets crisis.

In US economic data factory orders rose by 2.3% (forecast: +2.1%) in August. Challenger job cuts lifted to 55,285 (forecast: 38,700) in September from 38,472 previously. Initial jobless claims fell by 8,000 to 207,000 (forecast: 213,000) last week. Unemployment is now at 20 year lows and average hourly earnings continue to rise.  Overall household wealth continues to rise with increasing house prices and rising share markets. Naturally, consumer sentiment and confidence have strengthened further.

Indicators of US business activity remains strong despite rolling off recent highs. The US Fed is keeping a keen eye on inflation and has raised rates to 2.00%. The strong growth implies that the US Fed will remain upbeat in its economic forecasts and is likely to continue tightening monetary policy beyond neutral policy settings when the economy eventually overheats. Economists anticipate an almost certain chance of another rate rise in December.

Bond markets finally reacted to the strength of the US economy with the long end of the yield curve turning up. The 10-year note had traded as high as 3.232% – its highest level since May 2011 – as markets anticipated that monthly US jobs data, released on Friday, would be stronger-than-expected. But the sell-off lost some momentum with US 2-year yields down by 1 point to 2.8721% and US 10-year yields flat at 3.1889% on Wednesday 4th.

The flow on effect of the strong US economy, rising interest rates and rising bond yields is a strengthening USD$. The Euro is around US$1.1539. The Aussie dollar around US70.63 cents. The Japanese yen is around JPY113.63. This is causing some trouble in emerging markets with some significant currency falls particularly with Argentina and Turkey however they also have other issues that have contributed. It is not expected that emerging markets issues will cause some sort of economic / debt contagion at this time, but it is a risk we are mindful of.

In China, GDP is unsurprisingly consistent at 6.7% year-on-year. The trade war with the US will bring some unusual economic readings. Chinese exports have been bringing forward exports to the US to beat the tariff increases. In fact in August, exports rose 9.8% year-on-year. This trend should continue for a few more months but will eventually lead to a sharp reversal. It will be up to the Chinese consumer to rapidly pick up the slack.

More broadly in the Asia region, Investment Committee member Victor Yeung comments; “In US Dollar terms, Japan and India are the only two Asia Pacific market indices that have positive year-to-date performance as of the end of August. Granted, negative short-term news flow was not helpful to emerging markets. For example, the China and Hong Kong markets had a weak summer because of the overhang of the potential US-China Trade War.  And currency weaknesses in Venezuela, Turkey, Indonesia and Malaysia have also contributed to the gloomy investment landscape.

Many of these events are still developing and we expect emerging markets to continue to under-perform major developed markets over the next several months……….We are seeing signs that Japan’s economy is finally on a more solid footing. During the 1990s and 2000s, the Japanese economy kept under-performing its peers, and thus its stock market also under-performed. It was also known as Japan’s Lost Decade.

However, Japan’s fortunes seemed to be finally turning around since 2012.  Tourist arrivals, for example, have grown from about 9 million arrivals per year in 2012 to

over 28 million in 2017.  The monthly arrivals in 2018 so far have also recorded double-digit growth year-over-year.  In addition, this growth has been relatively balanced, with its top source of arrivals split quite evenly between China (25.6%), South Korea (24.9%), Taiwan (15.9%) and Hong Kong (7.8%)…….. The macroeconomic trend for Japan is not entirely benign. With its rapidly ageing society and reluctance to accept immigrants, Japan’s shrinking population would be poised to be a problem for it to maintain its status quo as the third largest economy in the world. In addition, its government debt is also amongst the highest compared to other developed economies.

However, in selected industries, Japanese ingenuity is sparking a comeback, bringing hopes that the country can overcome its economic challenges. Thus, we believe that its long term prospects are also improving. As the rest of Asia may see more negative news flow over the short term, we believe that a diversified stock portfolio should not ignore Japan.”

In Australia, economic growth continues to lift despite a soft housing sector. Annual GDP growth is now close to 3.4% year-on-year. Strong GDP growth has lifted employment growth and helped drive the unemployment rate to a six year low of 5.3%. Political in-fighting has been a contributor to a downturn in business and consumer confidence. A Federal election will likely occur in May 2019 with most factoring a change of Government to Labor. Current Labor policies on franking credits and negative gearing have the potential to drive house prices and equity markets lower and thus overall household wealth lower. This could change the interest rate outlook from an expected increase to a rate cut.

For now, economic growth is strengthening, unemployment is falling and wages are starting to warm up. These strengths could be enough to fend off any negative influences on growth. The RBA maintained interest rates at 1.5% but noted that pressure is mounting for a rate increase. We are watching, inflation, wages growth and AUD$ v USD$ for any rate increase. Any

fall of the AUD$ below USD$0.70 for any sustained period may force the RBAs hand regardless of other factors.

Globally, low level of interest rates continues to support advanced economies although the trend is for rates to gradually increase in the foreseeable future. The US-China trade war is a growth inhibitor and we are keen to see how it evolves post the US mid-term elections. Emerging economies also pose a threat however are not expected to cause broader implications for the global economy.

Disclaimer:

This information was prepared by Royston Capital, ABN 98 158 028 392 AFSL 438262. The information in this presentation is current as at 5 October 2018 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.

© 2018 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: Admiral Investments, Alexander Funds Management (Steven Roberts); RBA, CommSec