Economics – The Global Overview
The gradual upswing in global economic activity continues to gain momentum. Since our last update in August, the IMF has again upgraded global growth projections to 3.6% in 2017 (up from 3.5%) and to 3.7% in 2018 (up from 3.6%), citing broad-based upgrades in the Euro area, Japan, emerging Asia, emerging Europe and Russia as more than offsetting downward revisions to the UK and US. The improvement means the loose monetary policy that has been in place for almost a decade is coming to an end in the UK, Europe and the US as the need for stimulus recedes. Japan remains the exception. In its September update, the OECD points out its key areas of vulnerability in sustaining a global economic recovery over the medium term:
- Business investment and trade are both currently expanding, but remain weaker than recorded in previous economic recoveries;
- Wage growth remains sluggish despite rising employment and that means there are only limited gains being made in disposable household incomes;
- The need for deeper reforms in emerging economies to target more investment and productivity growth and overcome the headwinds generated by rapid demographic developments in some of these countries and a further moderation of growth in China. The danger highlighted is that ‘financial vulnerabilities such as high debt, currency mismatch between debts and revenues and rising non-performing loans could derail the medium-term growth outlook’.
- The need for ongoing monetary support to ensure the recovery is sustained and inflation increases towards target levels.
In Japan, Prime Minister Shinzo Abe called a snap election seeking a mandate for his hard-line approach toward North Korea. Election victory was secured in a landslide but widely regarded to be the result of lack-of-choice rather than the popularity of his policies. The win affords the ruling coalition a two-thirds majority in the Lower House that, coupled with the same type of majority in the Upper House, would let Abe call a national referendum to reform Japan’s post-war pacifist constitution, allowing Japan’s Self-Defence Force to become a bona fide military in law. In September, Germany’s Angela Merkel was re-elected Chancellor for a fourth time with her Christian Union bloc securing 33% of the vote – the worst return since established in 1949. Nearest rivals, and previous junior coalition member, the Social Democrats came in second with an historically low vote of about 21%. They subsequently dissolved the coalition and will sit in opposition. After six weeks of negotiations coalition talks built around Christian Democratic Union (CDU), its Bavarian sister party the Christian Social Union (CSU), the pro-business FDP and the Green party have collapsed over differences on migration and energy policy. From here, Merkel could seek agreement to form a minority government with either the Greens or the FDP, garnering support from other parties on an individual policy basis. Should that fail, Germany’s president could dissolve the current parliament and call for a fresh election.
Theresa May has her own problems in the UK. She is pushing for a hard Brexit but is meeting opposition both within and outside her party room. The UK government needs to clarify its position but the hung parliament and pro-Europe conservative members make progress slow. The trade deal and the financial settlement need to be agreed within a year if it is to be debated and approved by 2019. Current talk is that May is now poised to bow to the demands from her own party that the 11pm, 29th March 2019 Brexit time and date be dropped from legislation governing the UK’s withdrawal. Lobby groups are applying pressure because the lack of progress and certainty is acting as a roadblock to business contingency planning and investment. They want a ‘status quo-like’ transitional arrangement with the UK staying in the customs union and the single market. All this flies in the face of the ardent Brexiteers and the referendum result.
US President Donald Trump’s early November Asia tour, maintained the hard-line on North Korea and focussed on trade and investment. In particular, the rectification of what he regards as a massive trade deficit for the US. That deficit amounted to USD347 billion last year. In a bid to ‘level the playing field’, Trump’s delegation included about 30 CEO’s from notable US organisations and the US Commerce Department has revealed that 37 major deals, much in the energy and technology sectors, were signed between U.S. and Chinese companies during the trip. The combined value of these deals totals more than USD$250 billion. In other notable news, Mr Trump has nominated Jerome Powell to replace Janet Yellen as Chair of the US Federal Reserve when her first term ends in February. Powell’s nomination follows the resignations of Obama appointees vice-chair Stanley Fischer and point-person on safety and soundness of the financial system, Daniel Tarullo earlier this year. It is unknown at this stage if Janet Yellen will continue to serve on the board after February 2018 or if she too will resign.
Mr Powell has been a member of the Federal Reserve Board of Governors since 2012, studied politics and law and has a background in private equity rather than economics. Powell has a reputation of being dovish i.e. he favours looser, more accommodating monetary policy to stimulate growth in the economy. He has never dissented from any decision since joining the board. He is described as a moderate and a consensus builder and Wall Street appears supportive of the nomination, believing a Powell-led Fed will represent stability and policy continuity for markets. Despite the confidence from Wall Street, the resignations imply change is in the air and in further evidence of a change in the stewardship of US monetary policy, the latest high-profile resignation is William Dudley, president of the Federal Reserve Bank of New. He has voiced concerns about the Trump administration’s trend toward deregulation and against rolling back laws aimed at keeping large banks and Wall Street firms in check. Because the US economy continues to strengthen with the labour market tightening and inflation stabilising after a string of weak monthly readings, the Fed decided at their late September meeting to begin reducing the amount of assets on the balance sheet from USD$4.5 trillion to between USD3-3.5 trillion by 2020. To highlight the size of the balance sheet – pre GFC levels were around the USD 800 billion level. US equities returned 4.5% over the September quarter and have continued to strike new highs in October and November as investors focussed on Trump’s proposed tax cuts for business and shrugged off any temporary drag on growth that might arise as a result of the recent hurricanes. The S&P500 is up 15% in capital value for the year to date, while Nasdaq listed technology and biotech’s have been particularly strong, returning 32% and 25% respectively over the course of 2017.
European equities have notched up gains on reduced euro-scepticism risks in Germany and a broad-based rebound in both the core and peripheral economies. The FTSE Eurofirst300 Index is up 7.2% over 2017 with strong gains being made in Germany and France. The UK market has lagged, with the FTSE up 5.3% for the year. While Japanese equities also benefited from stronger economic fundamentals and the re-election of the Abe government. Emerging markets have been strong as a block, led by the Brazilian and Indian indexes – both up in excess of 20% and China’s Shanghai Composite up 8.9%.
Domestically, it’s been a messy few months for the coalition government. The lack of unity and the citizenship fiasco continues to suck oxygen from the government’s agenda and negatively impact both the government’s and the Prime Minister’s popularity. In an environment of considerable political instability, a strong yes vote on marriage equality and easy passage of its legislation, combined with strong wins in the New England and Bennelong by-elections and an improved economic outlook, could combine to provide some much-needed clean air and positive sentiment for the government and the Prime Minister in the run-up to the Christmas break.
After a flat quarter for the sharemarket between July and September, the market took-off in October. The S&P/ASX200 traded in a roughly 40-point range over the first quarter of FY18, from a July start of around 5720 points to a September end of 5680 points. In the last six weeks through October and the first half of November, markets have rallied over 300 points or around 5%. The co-ordinated global growth we are seeing is supportive of commodity prices and this is good news for the Australian share market. Both the All Ords and S&P/ASX200 indices pushed through the psychological 6000-point barrier for the first time since 2008 and both sentiment and momentum remains positive. As we write, the indices sit at 6057 for the All Ords and 5990 for the ASX200. In the absence of any compelling domestic growth signals, it would appear our market is being dragged higher by offshore momentum and the promise that improved employment numbers will eventually trickle through the economy and loosen consumer wallets. The recent rally in energy prices underpinned buying in market heavyweights BHP, Santos, Woodside and Origin. More specifically, the best performing sectors over the last 12 months were Information Technology (40.98%), Healthcare (34.32%) and Utilities (27.22%) with the major drag being Telecommunications (-23.27%) due the weakness in Telstra, TPG and Vocus.
Mergers & Acquisitions
Domestically, the foreign takeover of service provider Programmed Maintenance Services (PRG) by Japanese behemoth PERSOL, was approved and implemented in October along with the payment of a special fully franked dividend. In addition, the much-maligned merger between Tatts Group and Tabcorp Holdings is likely to go ahead even with substantial concerns from the ACCC, as the Competition Tribunal noted there is no ‘rule of law’ that could stop it. Interestingly, after a difficult period for the Murdoch family, rumours arose that Walt Disney Co, owner of ESPN, Star Wars, Marvel and the well-known theme parks, was interested in buying a number of 21st Century Fox’s domestic US and Global channels including Sky PLC and India’s Star TV.
- The EU delivered its strongest GDP growth rate since 2011, at 2.5% on the back of another strong quarter of recovery (+0.6%). The strength was broad-based with Germany (0.8%), Italy (0.5%) and France (0.5%) all contributing. In the UK the story was similar, with the economy defying the gloom to grow another 0.4% in the quarter.
- Such was the strength of the UK economy that the Bank of England doubled the cash rate, from 0.25% to 0.50%, in an effort to stave off the tumbling Pound and protect the economy from increasing inflation (3% in October). The ECB kept rates on hold, but surprised markets by announcing its bond buying program would be halved to just $30bn per month from January.
- There were positive signs throughout the economy with the consumer continuing to rebound, retail sales were positive once again, 0.7% for October and 3.7% yoy.
- UK Foreign Secretary Boris Johnson continues to heap pressure on PM Theresa May by pushing for a ‘Hard Brexit’ and refusing to make any divorce payments to the EU; there appears to be some pain ahead for the UK.
- The EU is seemingly joining the synchronised global recovery, with banking lending picking up and the consumption and service sectors benefitting from a weaker euro and reducing unemployment. Corporate earnings season was well received with most markets rallying strongly.
- The biggest risk to recovery lies in the political space, with the Catalonian independence vote and Germany’s hung parliament likely to be a short-term drag on reform and growth.
- EU PMI’s are pointing (58.5 for manufacturing, 55.0 for services) to the strongest expansion in factory activity since 2011
- EU bond yields continue to defy understanding, contributing to some $11tn in negative yielding bonds traded globally. Any sign of a reversal of bond yields may put too much pressure on the recovery.
- The economy delivered encouraging inflation data, with the CPI up 0.1% for the month taking the annual rate to 2.0%. Retail sales continued to grow, up 0.2%, after adding 1.9% in the prior month, pushing through the impact of recent Hurricanes.
- The GDP growth trajectory continues, with the US doing the heavy lifting, generating an annualized 3% in the third quarter, beating the expected 2.5%. It was once again driven by a recovery in consumption, however, the weaker USD has supported exports materially.
- Full employment remains in sight, with unemployment hitting just 4.1%, which is putting pressure on wage growth and supporting the Fed’s ‘normalisation’ of interest rates.
- Even with the positive news, the Federal Reserve kept rates on hold during the quarter. They did however announce that their $4.5tn balance sheet would be unwound beginning in October. The process will involve them simply not reinvesting the proceeds from upcoming bond maturities; the question that will determine the direct for bond rates, is who will pick up the slack?
- Once again it seems the US consumer may be lifting the global economy out of the stagnation experienced since 2009. Forward looking data suggests that a 4.5% annualised GDP growth rate is achievable in the final quarter. This is supporting demand for Chinese, European and Japanese goods.
- Whilst there is still a lot of work to be done, the passing of Trump’s tax reform bill by the lower house is a positive for sharemarkets and confidence in the Government.
- The US reporting season suggests good times are ahead, with 74% of S&P 500 companies reporting positive EPS surprises and the average growth rate of earnings reaching 6.2%. Analysts expect these to move to double digits in the final quarter.
- Shinzo Abe consolidated his power with another landslide election victory. The increasing strength ensures the growth focused Abenomics will continue. Thus far it has delivered solid results, with GDP up 0.3% for the quarter (1.4% for the year), the 7th consecutive positive reading which is the best result in more than a decade. The weaker Yen has resulted in higher exports but also contributed to higher inflation, 0.7%.
- The Chinese People’s Congress went off without a hitch, with Xi positioning the country to be a ‘mighty force’ in political, economic, military and environment issues in the decades to come. Cutting pollution, avoiding a debt explosion and ensuring a smooth transition to a consumer-led economy remain the key focus for the next decade.
- The economy appears to be making strides, with the growth rate once again at 6.8% but most important, 65% of this growth is now coming from consumption. The improving global economy is supporting demand for exports once again, they were up 6.9% for the year, with the US (+8.3%) and EU (11.4%) particular highlights.
- ‘Steady as she goes’ appears to be the case in Asia, as well flagged reforms and policies are given time to feed through to the economy. The North Korean affair represents a short-term threat to markets, but not necessarily a risk to recovery. Both China and Japan are enjoying the benefits of a stronger EU and US economy.
- Japan’s QE remains at full pace, with reports the Bank of Japan now owns some 70% of all ETF’s attracting headlines, yet this represents less than 5% of the market capitalisation of the index.
- The big question remains around China’s ability to manage its deceleration effectively, with a particular focus on highly leveraged state-owned enterprises. The decision to freeze smelting plants for the next three months will be an interesting test for Australia’s iron ore companies.
- Unemployment has continued to buck the overall trend of the economy, falling to 5.4%, however the recent closure of the motor vehicle manufacturing plants and large scale bank employee cuts is yet to feed through.
- Inflation was well below expectations at 1.8%, with huge energy price increases being offset by falls in staples like food, drinks, furnishing and clothing.
- Consumption remains held back by low wage growth, just 0.5% in the quarter. Historically low growth combined with increasing energy prices, higher interest rates and leveraged families has seen retail sales in the doldrums, reporting contractions of -0.3% and 0.5% in July and August and no growth in September.
- Interestingly, business sentiment is at all times highs (and the ASX hit 6,000 points for the first time in a decade) but consumer sentiment is in the doldrums; there is substantial disconnect between Collins Street and Main Street.
- It’s becoming apparent that the property market has peaked, with approvals slowing but a substantial amount of supply yet to come on line. This is concerning, as whilst a great deal of attention is paid to sharemarket collapses, it is in fact housing crashes that lead to recessions, due to the large amount of leverage allowed by the financial sector and the flow on for spending.
- There is hope that a rebound in infrastructure and low employment will be enough to offset a fall in residential investment, however, it seems Australia is in for a period of below trend growth.
- Whilst we are not doomsayers, we are confident there won’t be any rate hikes anytime soon as consumers are simply too leveraged and wage growth too weak.
- The biggest threat in our view is the much publicised slowdown in Chinese construction and reduced capital flows.