DECEMBER QUARTER 2018 COMMENTARY

Transcription

1 DECEMBER QUARTER 2018 COMMENTARY Economic conditions evolved substantially as expected during the December quarter, with economic growth continuing at above-trend rates and inflation remaining contained in most advanced economies. However, signs of increasing divergence in economic prospects continued to emerge, and broadly growth rates slowed. The 10-year anniversary of the Global Financial Crisis (GFC) and a spike in volatility on investment markets (more on that later) prompted more talk of the probability of recessions in certain advanced economies. However, we note that there are few, fundamental signs (that is, in the economic data) yet of increased risk of recession during 2019 in most major economies other than the modest slowing of growth rates and the natural increase in the time since the last recession continues to extend which is no concern of itself. The exception may prove to be in the United Kingdom where the deal proposed by the European Union (EU) and Prime Minister Theresa May was voted down in the UK parliament thus raising the risk of a no-deal exit from the EU (so-called Brexit) which many believe would lead to a recession in the UK. In December after the G-20 summit in Buenos Aires, the United States (US) and China agreed to a 90-day halt to the imposition of new trade tariffs to allow for talks between the two superpowers, thus deferring the increase in the rate of some US tariffs on Chinese imports that was scheduled to apply from 1 January Shortly thereafter the US entered another period of partial Federal government shutdown as President Donald Trump seeks agreement to his US$5bn plan to build a wall along their border with Mexico i. The shutdown continues today and while such a process is completely foreign to us, it is far from uncommon in US politics. In the US, mid-term elections returned a widely anticipated result with the Democrats taking over the House of Representatives and the Republicans consolidating their position in the Senate, resulting in expectations that fiscal stimulus won t be extended and consequentially that growth may slow (i.e. relative to expectations if fiscal stimulus were extended as previously expected) ii. The US economy posted another above-trend rate of growth for the third quarter of 2018, recording GDP growth of 3.4% (revised down from the initial reading of 3.5%), down from 4.4% during the June quarter, although this was higher than the March quarter growth rate of 2.2% iii. The very high growth rate during the June quarter resulted from the initial impact of the large tax cut package, and effect which is expected to fade during The strength in US employment conditions continued with Non-Farm Payrolls increasing by another 250,000 in October, 176,000 (revised) in November and 312,000 in December, and after reducing to 3.7% in November, the unemployment rate ticked up to 3.9% in December on the back of improved participation iv. US inflation rose during 2018 as elusive wages growth emerged, as well as commodity price increases and rising producer prices. Inflation rose from 1.6% at the start of the year to end in line with the US Federal Reserve s ( Fed s ) 2% target v. As noted earlier, the Fed has confirmed that they will apply their inflation target as an average rate over time, rather than an absolute target with action to be taken as soon as it is achieved. After remaining below target for such an extended timeframe, the Fed determined that continued economic and employment growth warranted another step on the path to the return to more normal interest rates raising rates by 0.25% to % in December, as widely anticipated and marking the fourth rate rise during the year vi. Notwithstanding the ready explanation for the slowdown in growth in the US from the June to September quarters (declining impact from the tax stimulus package), many of the economists we pay attention to are expecting US growth to continue to gradually slow, however given the strength of the starting position, many do not see significant risks of a recession in the US until Intuitively this makes sense given that abovepotential growth rates cannot continue indefinitely without improvements in productivity that outpace economic growth. Page 1

2 Against a very different potential growth profile to the US, the Eurozone also delivered above-trend growth, with GDP growth of 1.6% for the third quarter of 2018, while inflation remained steady at 1.0% over the year to December. vii Challenges remain on the horizon for the Eurozone if these above-trend growth rates are to be maintained for any length of time. Some of the challenges are relatively short-term in nature, including negotiations with Italy over their budget proposals, Brexit negotiations and subsequent trade negotiations with the UK, a changing of the guard at the European Central Bank (ECB) as President Mario Draghi s term comes to an end at the end of October and long-standing German Chancellor Angela Merkel s announcement that she would not seek another term, and some are much more fundamental relating to the structure of the EU itself. As announced, the ECB ceased the additions to its quantitative easing (QE) program in December and reiterated that rates would likely be maintained at the current accommodative level until at least the second half of 2019 viii. We note that many economists now expect European interest rates to remain on hold until The removal of the expansion of the QE program by the ECB is a first step towards providing scope to support the economy in a future downturn. We also note that given Europe s more meagre growth potential, lower recent levels of growth and higher unemployment, as well as structural and member-specific issues, the risks of a recession in Europe appear somewhat greater than in the US, and allow policymakers a smaller margin for error. The EU agreed terms with (or we wonder if this should more appropriately read, dictated terms to ) UK Prime Minister Theresa May, however, as mentioned, the UK parliament resoundingly voted against this proposed deal to for the UK to exit the EU. This was followed by a vote of no confidence in Mrs May, however she retained power. (Who would want this job?) It remains to be seen what comes of this debacle resulting from an overly simplified reference on a matter of such considerable importance, however the risk of a no-deal exit from the EU on 29 March 2019 has clearly risen, and many expect that would lead to a recession in the near term for the UK. We can only hope that the consequences of a no-deal Brexit are realised sooner rather than later and lead UK politicians to see that a deal that compromises some of their specific wishes is markedly preferable to no deal. Prior to the recent vote, the Bank of England provided this chart showing the potential outcomes from Brexit in a range of scenarios relative to the extension of the growth rate the UK experienced prior to the referendum in We note that even the most favourable scenario they considered is materially detrimental to the UK, and the two no deal scenarios set the UK economy back somewhere between 3 to 6 years! Source: Morningstar Insights, Brexit A Morningstar View, 18/12/2018 Critically, this analysis considers only the impact of Brexit itself which relates only how the UK leaves the EU; it ignores the impact of the future arrangements entered into by the UK with the EU which cannot be negotiated until after the UK has exited the EU and the individual trade deals that the UK will then need to negotiate with the rest of the world, and which they can only negotiate after they have entered into a new forward-looking Page 2

3 agreement with the EU. We can only hope that many important lessons are learned from the UK experience for the EU and other Eurozone member states; core among them has to be that a referendum cannot be held again that simply considers a yes/no question without any consideration of what a vote to leave the EU actually means or the form future engagement with their largest trading partner should take. Japanese core inflation remained stubbornly low during 2018 at close to 0.0%, well below the Bank of Japan s ambitious 2.0% target, however signs of wage inflation strengthened on the back of a 25-year low unemployment rate of 2.4% ix. The Chinese economy posted growth of 6.6% during 2018 according to a first official estimate, above the target rate for 2018 of 6.5% x. While many seem to take delight in pointing out that this is the slowest pace of growth since 1990, no one can reasonably expect an economy that is now many times the size it was at that time, and now the second largest global economy, to continue growing at a pace that it was able to achieve when it was a smaller economy. Furthermore, and as we have said many times, the contribution that the Chinese economy makes to global output is now many times larger than it was even five years ago, let alone 28 years ago. Oil prices were another significant factor during the December quarter. After reaching a four-year high in early October, oil prices fell dramatically during the remainder of the quarter, including 9.6% during December alone xi. Over the course of 2018, oil prices fell nearly 25% xii. Australia s strong growth outcomes continued as well, with GDP for the year to the end of the September quarter of 3.0%, down from the robust rate of 3.4% achieved in the year to the end of the June quarter. Inflation eased back to 1.9% in September, from 2.1% in June. The economy continued to add jobs at a healthy pace with 28,700 positions added in October and 37,000 in November, leading the unemployment rate to reduce to 5.1% in November xiii. In their January update to their World Economic Outlook, the International Monetary Fund (IMF) reduced their growth forecast for the global economy for 2019 from 3.7% to 3.5% for 2019 and from 3.7% to 3.6% for 2020 xiv. In their release they noted: The further downward revision since October in part reflects carry over from softer momentum in the second half of 2018 including in Germany following the introduction of new automobile fuel emission standards and in Italy where concerns about sovereign and financial risks have weighed on domestic demand but also weakening financial market sentiment as well as a contraction in Turkey now projected to be deeper than anticipated. In the last edition we included an IMF chart showing Real GDP Growth since 1980 and including the IMF s forecasts for the world (orange line), advanced economies (light blue line) and emerging market and developing economies (dark red line). We now include the updated version of this same chart below, however now with the following countries/regions added: Australia (green line), China (purple line), United States (darker blue line) and European Union (red line). We note that the change to the forecasts for the world economy is barely discernible from the previous version of this same chart. Page 3

4 In their Economic and Market Outlook 2019 and Beyond, Mercer summarised global economic conditions as follows: Economic growth in 2018 was strong but less broad-based than in The US led the pack on the back of solid economic fundamentals, for both the household and the corporate sector, and a boost by the tax cuts and spending increases. Economic growth elsewhere was more mixed, with regions like the eurozone losing momentum. We expect global economic growth in 2019 to weaken slightly. The period of US exceptionalism is likely to fade as growth in the US slows from the highs seen in 2018, but growth should remain at decent levels elsewhere xv Investment Markets Investment markets told a different story altogether to the economic data during the December quarter, with some significant losses late in With interest rates in Australia remaining unchanged again at all-time lows, Australian cash again provided a modest return of 0.48% for the quarter and 1.92% for the year. Australian and international fixed interest markets provided some diversification to growth assets during the quarter and especially during December, with Australian fixed interest achieved a return of 2.24% for the quarter and 4.54% for the year. International fixed interest rebounded from a loss during October to end the quarter with a total return of 1.66%, and a very similar return for the year of 1.65%^. Property investments in Australia and overseas posted negative returns for the December quarter, with Australian Real Estate Investment Trusts (A-REITs) losing a relatively modest 1.71% causing the return for the Page 4

5 year to reduce to 3.27%. Global Real Estate Investment Trusts (G-REITs) were highly volatile throughout the quarter and ultimately provided a return of -6.23% for the quarter and -4.26% for the year. Both Australian and international shares provided negative returns in each of the three months of the quarter, although the diversification provided by currency exposure was clearly seen again with unhedged international shares significantly outperforming hedged exposures as the Australian dollar depreciated against the US dollar by 2.27% during the quarter and 9.94% during In the end, Australian shares lost 8.24% for the quarter and posted a total return of -2.84% for Unhedged international shares lost 11.10% for the quarter, however earlier strong gains kept the return for 2018 altogether in positive territory at 1.52%. In stark contrast, hedged international shares provided a return of -7.6% for Market Index Returns empowering your financial evolution TM The table below summarises the returns for key market indices for the period to the end of the quarter: Please note that the index for Global Property is hedged into Australian dollars thereby removing the impact of movements of the Australian dollar whereas for International Shares the index shown is not hedged meaning that this index includes the movements of the Australian dollar. Please note that these returns are before tax. General Advice Disclaimer The views expressed is this publication are solely those of the author; they are not reflective or indicative of Millennium3 Financial Services position, and are not to be attributed to Millennium3. They cannot be reproduced in any form without the express written consent of the author. Page 5

6 The information (including taxation) is general in nature and may not be relevant to your individual circumstances. You should refrain from doing anything in reliance on this information without first obtaining suitable professional advice. You should obtain and consider a PDS before making any decision to acquire a product. Opt Out Clause: Mammoth Financial respects your privacy. Should you wish not to receive further publications please contact our office. yours sincerely, alex morris CFP SSA director & authorised representative mammoth financial pty ltd Contact Details Please feel welcome to contact our office via the contact form on our website or using any of the details below: p f e alex@mammothfinancial.com.au Sources: i ABS News, The US federal Government has shut down for the third time in a year, so what happens next?, 22/12/2018 ii ANZ Wealth, Chief Investment Office, Market Watch, November 2018 iii & Mercer, Market & Economic Conditions, September 2018 iv Mercer, Australian Monthly Market Review, October 2018 & Mercer, Australian Monthly Market Review, December 2018 v Mercer, Economic & Market Outlook 2019 & Beyond, December 2018 vi vii viii ix ix Mercer, Economic & Market Outlook 2019 & Beyond, December 2018 x CNBC ( China 2018 GDP: China reports economic growth for fourth quarter, year, 21/01/2019 xi xii xiii Australian Bureau of Statistics, Key Economic Indicators, accessed 22/01/2019 xiv International Monetary Fund, World Economic Outlook Update January 2019, A Weakening Global Expansion, 22/01/2019 xv Mercer, Economic & Market Outlook 2019 & Beyond, December 2018 Page 6