21 May April Market Commentary
A result of the recent short term volatility and overall declines in major indices around the world are better valuations and hence improved forecast returns from these lower prices. Overall the shifts have been largely proportional relative to other asset classes.
The more things change, the more they stay the same, or so the saying goes. Consider this quote that was part of a recent investment conference presentation1: “We are in a period of the most wonderful progress in science and invention, especially as applied to communication and transportation, this or any other country has ever known. It is obviously our present great fortune to live in what, in the light of history, will be recognized as a golden age of American industry.” What is noteworthy about the quote is not the sentiment expressed, but the fact that it was published in the summer of 1929. Similar sweeping statements have been made at regular intervals throughout history, and whilst these sorts of technological advances are of course welcomed as we advance as a global society, the same speaker highlighted that over very long periods of time that economic growth rates have been remarkably stable.
This chart1 shows clearly several large deviations from the long term trend growth of 1.85% in GDP per capita in the United States, understandably around events such as the Great Depression and World War II. However, it also shows quite clearly how powerful the force to revert to long term trend growth is over time.
This is a central element of why we forecast for the long term and how we manage the asset allocation positions in your portfolio. It should also remind us that the fundamentals of investing shouldn’t be cast aside because ‘it’s different this time’ – rather, a diligent and disciplined implementation of time tested and robust portfolio management methods will give you the best chance of steadily growing your capital and providing for your long term income requirements.
The next President of the United States won’t be inaugurated until January of 2017, almost two full years away, though the election campaign is already gaining significant momentum. At this early stage we have two declared candidates for the Democratic presidential primary elections, and six from the Republicans – along with the prospect of as many as a dozen or fifteen more candidates joining the race from both sides. Suffice it to say that the circus is in town and the noise surrounding management of the US economy is about to get a whole lot louder, and potentially for some more difficult to tune out.
Markets coped with a negative surprise in April as the economic growth figure for the first quarter of 2015 was released. Whereas the consensus expectation was that the US economy was likely to have expanded at 1.0%, the actual result came in at just 0.2% and even that low figure is expected to be downgraded as future revisions are made to the data. The Federal Reserve Bank of Atlanta releases regular analysis known as GDPNow2, which uses the concept of ‘nowcasting’ rather than forecasting, by taking contemporaneous economic data to progressively build a growth picture as opposed to waiting for the delayed quarterly official releases. They were very accurate on the Q1 GDP number, and at the moment, though still early in the quarterly cycle, the data says that the US economy likely grew at an annualised rate of just 0.8% in Q2.
This growth, or lack thereof, has important policy implications for the trajectory of interest rates in the United States, but will also have flow on effects to other markets around the world. The moment of ‘liftoff’ for rates is now thought by many to be the September meeting of the Fed’s rates committee, though we would reiterate that there is no reason to expect Chair Yellen and her committee members to be other than as they have described themselves for a long time now, and that is ‘data dependent’. If confidence in the robustness of the US economic recovery is not restored with a strong bounce in Q2, such as we saw in 2014, we should not be surprised if US interest rates stay at zero for a while longer.
The other critical data that the Fed is paying attention to relates to the labour market, and specifically any confirmation that the steadily
falling unemployment rate is starting finally to exert upward pressure on wages. Here the data is mixed, on some measures there does look to be signs of improvement, but on at least one key measure – Average Hourly Earnings3 (Dark Blue), what were signs of growth have rolled over a little in the most recent data. Alternative measures of wage inflation are showing a pickup, which was absent this time last year, so perhaps this will be a sufficient catalyst for the Fed to move; only time and the data will tell.
Another record low in interest rates was set by the Reserve Bank at their meeting in the early days of May, taking the Cash Rate down to 2%. In addition to the traditional accompanying statement, which caused some confusion in markets, we shortly after received some clarification from the bank in the form of their quarterly Statement on Monetary Policy. The confusion mentioned related not to the cut itself, which was widely anticipated, but to the language which some took to indicate that this may be the bottom of the rate cycle. The RBA noted encouraging signs in demand from the household sector, though expected that business investment (both mining and non-mining) was likely to be weak over the next year. With local inflation in check and rates around the world likely to stay low – or indeed with some central banks “stepping up the pace of unconventional policy measures”4 – the board judged there was scope for additional support to the economy by lowering rates. As to the future course of rates, we should simply expect that the RBA will in their own way also be ‘data dependent’ and will make their best judgment as to the right policy mix with the information available at the time.
This diagram5 provides a useful snapshot of the state of the household sector, showing only modest gains – but gains nonetheless, in both real disposable income and consumption, the former likely helped by the recent decline in oil prices. What is perhaps most interesting is that the saving ratio remains at historically high levels, indicating a mood in the household sector that is consistent with survey data showing confidence is lagging. In the short term that is a drag on our economic growth, as money saved is not being spent and perhaps in part explains the anticipated weakness in business investment and also the expected further slight rise in unemployment. In the longer term though it means we have significant potential for expansion when confidence returns. That is however not happening right now, as a popular gauge of consumer sentiment6 has been consistently below a reading of 100, indicating that on balance the number of consumers that are pessimistic outnumber the optimists.
Were we to take our lead from the optimists, we would note that the Australian economy continues to grow at a pace in the mid 2% range that is broadly consistent with the US, which attracts plaudits for the strength of its recovery from many observers. We also have a central bank that is still able to use conventional monetary policy, i.e. interest rates, to support the transition in our economy. We have a ratio of Debt to GDP that has been rising but remains the envy of most developed nations. Whilst it would be a bridge too far to invoke Franklin Roosevelt and his famous quote “the only thing we have to fear is…fear itself” – it does appear that on balance there is sufficient cause for optimism in Australia, and in Australian equity markets given strong dividends and reasonable valuations.
1. Dr Ilian Mihov. The Rise of Asia: Trends, Risks, Uncertainties and Opportunities. IMCA Annual Conference 2015.
2. Centre for Quantitative Economic Research, Federal Reserve Bank of Atlanta. GDPNow – 5-May-15.
3. US Average Hourly Earnings Private NFP (Prod & Non Sup In Nom$) YoY SA. Bureau of Labor Statistics & Bloomberg
4. Glenn Stevens, Statement: Monetary Policy Decision. RBA. 5-May-15.
5. Graph 3.6 from Statement on Monetary Policy. Reserve Bank of Australia. May-15.
6. Westpac-Melbourne Institute Consumer Confidence Consumer Sentiment SA – Latest reading 96.25. Apr-15.
DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of Paragem Pty Ltd AFSL 297276) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.