Quarterly Market Commentary July 2018

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

Global Economy

The global economy continues to expand although a few storm clouds are gathering in the name of Tariffs. Whilst Donald Trump’s intentions are to create more jobs for US citizens in older types of industry, it appears Europe, China, Mexico, and others, are likely to play tit-for-tat and impose their own tariffs on US goods, hence the recent headlines regarding Trade Wars.

Tariffs are never good for an economy as it creates price-push inflation, thereby increasing input costs to many goods and services, which reduces profits, which results in potentially higher unemployment and lower economic growth for all. The Smoot Hawley Act of 1930 increased Tariffs on tens of thousands of imported goods, and is widely regarded as a major cause for deepening the Great Depression. If higher tariffs persist by the US, this will likely cause higher equity market volatility, which is unlikely to result in a positive return outcome. The higher inflation may also lead to the Federal Reserve continuing their increase in interest rates, which may exacerbate the equity market volatility.

Global Markets

There have been numerous major market moves around the globe over the last quarter. Italy’s uncertain political environment, and their election of an anti-Euro government, created a sharp decline in Italian bonds, letting everyone know that all is still not well in Europe despite quietness in recent times.

At the time of writing, China’s sharemarket (CSI 300) is currently in a bear market having declined by almost 25% since January 2018. Whilst Chinese economic growth has been sound, this fall is likely driven by international trade uncertainties, and ongoing concerns around internal debt levels.

The US Federal Reserve has continued to indicate its intention to increase its cash rate, and the recent quarter still saw overall strong returns from most developed market risky asset classes, with other declines coming from High Yield bonds and Emerging Markets.

Global Risks

Global risks appear to be much greater today than during 2017 and are primarily due to the worsening International Trade situation. The USA have already placed tariffs on steel and aluminium imports and are currently in the process of expanding to other goods. Moving towards a trade war with the world’s second largest economy, China, will undoubtedly increase equity market volatility, as more industries are affected.

US Equity markets still appear to be overvalued compared to history, forecast growth, and other equity markets. This, combined with rising interest rates, may also add to equity market volatility, as quantitative tightening inevitably continues.

Australian Economy

The March quarter’s strong economic growth result of 3.1% year-on-year, was only the second time this figure has reached over 3% since 2012. The Reserve Bank believes this level is likely to be sustained for the remainder of 2018, and into 2019. A major part of the higher level of economic growth has been higher commodity prices helping the resources sector along with a steady Australian dollar.

Unemployment continues to be somewhat steady staying in its 5.4% to 5.7% range (most recently 5.4%) which has also kept wage inflation and consumer inflation at low levels, 2.1% and 1.9% respectively.

Australian Markets

Australian equity markets were amongst the best performing around the world during the June quarter returning more than 9%. After a lean 18 months, A-REITs also posted strong returns during the June quarter returning more than 10%. These were particularly sharp increases which are unlikely to sustain, although they come from lower relative valuation levels than overseas markets plus the Australian benefit of stronger commodity markets.

The Australian bond markets were relatively unchanged as cash rates and bond yields remained steady. Looking ahead, it is likely the Reserve Bank will keep interest rates at 1.5% for the remainder of 2018, although yield curves do suggest a 25bps increase later in the year.

The Australian dollar weakened marginally against the US Dollar and currently trades around $0.73US . This lower level provides a small amount of stimulus for the local economy and markets as our goods appear more attractively priced to overseas purchasers.

Australian Risks

The potential trade war between China and United States continues to present as Australia’s biggest risk, considering China is Australia’s largest trading partner. Australia’s economic growth still depends on a strong China whilst they continue to be Australia’s biggest export customer.

Locally, the decline in residential property prices, particularly Sydney and Melbourne, contribute to households being a little poorer and if this decline accelerates, may result in a significant reduction in household spending and weaker economic growth. However, at this point in time, the decline is not yet a major concern and, combined with the current low inflation levels, will contribute towards the Reserve Bank keeping interest rates low, despite rising cash rates in the United States.

Finally, the Royal Commission continues to create uncertainty for the Finance Services sector, which is the largest sector of the Australian sharemarket. Whilst the Australian sharemarket has had a strong June quarter, like the rest of the world, there is likely to be higher levels of market volatility during the remainder of 2018 than what was seen in 2017.