TAMIM Joint Managing Director Darren Katz takes a look at the financial world in month passed.
The last date for a federal election to be held under the overly complicated Australian Federal election rules is 18 May 2019. If you would like to understand the calculation process to figure out the date then you should take some time to read Anthony Green’s election blog. With the vacant seat of Wentworth due to be contested on the 20th of October perhaps we don’t even get to May. While the election is probably still a while away it is worth highlighting the key policy differences of the Australian Labour Party to the current government. While new policies would have to pass the upper house before becoming law it is likely that the ALP would gain the support of the Greens to force changes through.
The policy differences are:
Clearly a big issue for most Australian retirees is the proposed change to franking credits with a significant amount of SMSF trustees facing significant losses to real income under the proposed changes. This is likely to cause a change in behaviour and cause a shift in focus towards assets with a higher yield, quite possibly further up the risk curve, to make-up for these losses. We continue to watch with interest but we are also preparing for the likely change.
Globally the economic cycle continues to move closer to the conclusion of a strong expansionary period. We still believe that it makes sense to remain long risk but as risks appear and/or magnify we believe we need to continue to diversify portfolios, remain more liquid and be ready to act. We believe a shock could come from excess wage and inflationary pressure which would cause excessive central bank tightening (not on the horizon as yet) or an external shock to the system such as the trade wars, although we are still undecided on how far we believe the Trump administration will push this. The US economy, as mentioned last month, is booming with consumer confidence at its highest level since 2000, jobless claims at the lowest level since 1969 and wage growth at the highest level since 2009. US GDP Growth for the year to the end of the second quarter is 4.2% and this is the strongest level experienced in 4 years. The strong economy has helped drive US equities in September which in turn has driven developed market equities, represented by the MSCI World Index, up +7.1% in 2018 after a strong 3rd quarter (+5.4%).
A weak Australian equity market in September (-1.2%) resulted in the quarter looking weaker relative to the developed market result we saw above with the ASX200 up only 1.5% in the quarter. Over this time the equity market was driven by strong telecoms, healthcare, industrial and technology sectors while the financial and materials sectors proved to be big detractors. The Royal Commission (and the probable increase in regulation to come) coupled with a weakening housing market has seen pressure on the local market increase. The earnings outlook in Australia has started to weaken as a result. A bright spot does still remain though, tightness in the supply of oil on global markets is likely to support energy and oil shares. The energy sector has remained a consistent performer but is still the only sector trading below its 15 year average forward price to earnings ratio.
US rate hikes and the inability of the Reserve Bank of Australia to follow suit has resulted in the ongoing weakness of the AUD versus the greenback. Thankfully the weaker AUD does provide some relief to the economy. The economy expanded by 3.4% in the year to the end of the second quarter which was more than the marketplace expected. Household consumption was weak which is a concern but growth was still experienced in this segment as well as government spending. With savings rates low, low wage growth and high household debt to income the Australian household remains vulnerable. It is likely that growth through the balance of the year and for 2019 will be more muted than the current pace.
As stated above, we are still not sure of how far Trump will push the trade war as we remember the Mexican wall (put this in the context of the modernised NAFTA agreement with Mexico) and the threat of Nuclear Armageddon with Kim Jong Un. Having said this, the most obvious near term risk to global markets and the economy as a whole is the potential for further escalation in the US China trade war. The US has imposed tariffs on $250bn worth of Chinese imports. The retaliation from China has been to impose tariffs on approximately $110bn of US imports. As of January 2019 the current 10% US tariff is set to increase to 25% should a trade deal not be reached. A further threat of imposing tariffs on all Chinese imports has been leveled if China imposes any further retaliation. What does all of this mean? Well in a worst case scenario this creates a large drag on global growth and results in inflationary pressures. Our view is that calm will still prevail but the impact on business and consumer confidence is already being felt. On the positive side, an easing of trade worries will almost certainly result in upside for developed equity markets.
The other key risk to global markets, the Fed raising rates too far too fast, seems to be under control. The Fed raised rates in September once again. The rising yields have created volatility in the market but we need to remember rates are increasing in response to growth and not inflation and this should be seen as a positive signal for risk assets. Yield curve inversions precede recessions they do not cause them, you need to look at more comprehensive economic data to assess the risk of a recession.
Europe has weakened materially in exports since the start of the year. Most of this can be attributed to a slowdown in exports to China. This could lift as the Chinese continue to ease domestic lending policies to support domestic demand. The concern is that the weaker exports alongside higher oil prices will result in lower domestic consumption levels. Consumer confidence is off which coupled with the Italian political developments will cause greater volatility in both fixed interest and European equity markets.
In Japan, employment has risen to the highest level since 1974 and Japanese banks continue to expand credit. The weakening Yen (resulting from interest rate differentials to the US) has also helped Japanese equities with the Topix up 5.9% through the quarter. A slowdown of Chinese credit growth has weighed (along with the trade war) on the Chinese market. Chinese authorities are now easing policy to support domestic growth. They are still however retaining regulatory pressure on the shadow lending sector.
US equities remain the standout sector but risks are now elevated with a hawkish Fed and a President that is difficult to read. The greater risk to the global economy is that the current US expansion comes to an end. They all do at some point. We believe there is a long overdue swing back to value from growth as an investment style. There has been a noticeable differential between growth and value style valuations as well as a weak set of second quarter numbers from the FAANG constituents. It is not a matter of if, rather a matter of when.
Markets & Commentary
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.