Quarterly Market Commentary April 2019

Global Economy

• Whilst the global economy continues to grow, 2019 global economic growth forecasts are being downgraded with the most recent coming from the International Monetary Fund (IMF) which downgraded its previous (January) forecasts from 3.5% down to 3.2%. This change in expectations is driven by slowing economies in the developed world, in particular, Europe, and its major economies, Germany, UK, and Italy.
• Counter to the slowing economic growth has been the strong employment growth across major economies. Unemployment rates in the USA, Germany, United Kingdom and Japan have declined to multi-decade lows. This has resulted in increases in strong wages growth which is now more than 3% in USA, Germany, and the United Kingdom. This has not yet translated into inflation, but with the rebound in oil prices, which previously contributed to lower inflation, inflation may surprise to the upside later in the year.
• Whilst the outlook for China’s economic growth has also declined recently, its government has responded with fiscal stimulus which includes infrastructure spending. This is potentially a good sign for commodity prices, which augurs well for Australia’s Terms of Trade.

Global Markets

• After equity markets declined sharply in the December 2018 quarter due to stretched valuations and global growth concerns, they have come roaring back and have almost wiped the losses following the September peak. MSCI World index, representing the major global sharemarkets, produced a gross return of approximately 12.8% in local currency terms for the March quarter alone. Contributing to this success is positivity around corporate profits and increased likelihood of central banks stopping their interest rate increases.
• Strong equity markets usually coincide with strong economic outlook, which is contrary to current economists’ views, and also contrary to recent bond market behaviour. Bond yields around the world continued to drop in 2019. The US 10-year bond yield recently dropped below the Federal Reserve’s cash rate (currently ~2.4%) suggesting an inverted yield curve which is often a strong recession predictor.
• The current question for markets today, is who is right about the global economy? Bonds or Shares? … currently they appear to be in disagreement.

Global Risks

• Major risks continue to be unchanged and revolve around uncertainty. Uncertainty as to how Brexit looks in Europe, and uncertainty as to where the Trade Wars between US and China, and, US and Europe will land. Clarity on these issues are likely to produce greater economic certainty as government, companies, and households can plan spending more effectively.

Australian Economy

• The decline in Australia’s economic growth continued in the December quarter as growth dropped from 2.7% to 2.3%. This coincided with weaker economic growth from around the world, and particularly, Australia’s biggest trading partner, China. The other major factor contributing to weakness was the continued decline in house prices in Sydney and Melbourne.
• Despite the decline in growth, Australia’s unemployment level continues to improve and is now at 4.9%. With housing prices being a concern, the unemployment level becomes a key metric as any sharp increase could result in sharper housing price and economic growth declines as weaker confidence would likely take hold.
• Inflation was 1.8% for 2018 keeping it below the Reserve Bank’s target range of 2% to 3%. This result combined with weaker economic growth has resulted in the Reserve Bank shifting from its next interest rate move being up to down. That said, most economists do not expect a rate cut to occur until August at the earliest, assuming they are correct there is plenty of economic activity to assess before then.

Australian Markets

• The Australian sharemarket has largely followed global markets and the S&P/ASX 200 produced a strong March 2019 quarterly return of almost 11% (including dividends), meaning the losses of the December 2018 quarter are no longer.
• Once again, the bond market has not moved with the positivity of the sharemarket, and bond yields continued to drop in 2019. The Australian Government 10-year bond yield hit a record low of 1.73%, suggesting the long run economic outlook for Australia is not strong.
• The Australian dollar has so far remained relatively steady against the US dollar during 2019; trading between $0.70US and $0.73US. The high commodity prices and terms of trade have kept the Aussie dollar strong, despite the above-mentioned economic concerns. Should commodity prices, particularly iron ore, decline it would not be surprising to see the Australian dollar drop below $0.70US, but China’s recent fiscal stimulus should reduce that potential for the time being.

Australian Risks

• Chinese economic success will be a major driver of Australia’s economic success for many years to come so continued Trade Wars between China and USA is a major risk to Australia in the short term.
• The housing market in Sydney and Melbourne continues to decline but whilst mortgage arrears do not appear to be concerning, that could change if unemployment increases substantially. As mentioned above, unemployment is the critical metric moving forward.

This article was prepared by Michael Furey, Principal of Delta Research & Advisory, on behalf of the HPartners Group.