11 Nov October Market Commentary
A rebound in prices during October was relatively widespread in investment markets around the world, which has the effect of reducing future expected returns. Though as can clearly be seen, we remain of the long term view that there is significant value available and as such have maintained the exposures communicated in the August Quarterly Asset Allocation Update.
During the month there was a gathering in Lima, Peru that was hosted by both the World Bank and the International Monetary Fund which brought together government officials and observers from private institutions to discuss the state of the global economy. One of these observers encapsulated the mood of the conference as “Gloom, But Not Doom” in his subsequent report1, though it is worth noting this author had just published a view that the world was heading for a global recession. He went on to note that most attendees held a more optimistic view than his own, and it would seem at least in the very short term that that more optimistic view is having some influence on investment markets. Strong gains were recorded in most major equity markets around the world, alleviating at least in part some of the declines that had seemed pervasive in August and September.
Not surprisingly, the deliberations at the conference centred on China and Emerging Markets more broadly, including the possible effects of weakness flowing to Developed Markets and impacts on exchange rates. As we have done in these pages, it was noted that the response of the Chinese authorities to the equity bubble in mainland indices and a currency adjustment left a bit to be desired: “The perception that policy has been somewhat ineffective and hard to comprehend in some recent episodes has meant that some of our counterparts saw increasing risks that China would at some point in coming years suffer a sharper slowdown as it confronts its many policy challenges.” Of course, we now have updates from the recent gathering of the Chinese leadership which we will share below. As for the remainder of the Emerging Markets, the well known challenges were seen as just that and likely to lead in time to slower growth, but a crisis was not seen as likely.
Commodity producing developed economies such as Australia and Canada were thought to be most susceptible to this slowing, though only modest impacts were expected elsewhere in the developed world. US authorities were not immune to being chided for confusing messages about monetary policy in recent months, and their eventual first move in rates. Finally, in what can only be seen as a welcome outcome, Europe was not the centre of attention, save for noting the short term economic impacts of the refugee crisis, but also the long term potential economic benefits of the situation.
While European politics may not have been a hot topic in Lima, former Greek Finance Minister Yanis Varoufakis laid out a succinct summary of the political challenges that still await some form of resolution. Describing a scenario in which “fresh battle lines are being drawn”2 Varoufakis highlights three of the main protagonists in the process. Firstly, Italian Prime Minister Matteo Renzi is pushing back against the Germans and the rules they are seeking to impose on other member economies. “Renzi understands that adherence to German-inspired parsimony is leading Italy’s economy and public finances into deeper stagnation, accompanied by further deterioration to the debt-to-GDP ratio.” Secondly, he points to French Minister of the Economy Emmanuel Macron who is well regarded by the Germans but has recently spoken of “an impending religious war in Europe, between the Calvinist German-dominated northeast and the largely Catholic periphery” – a statement that deserves significant attention.
Finally, Wolfgang Schäuble in his role as Finance Minister in Germany has been one of the chief architects of the austerity programs that were administered and have since been shown to be ineffectual against the ailments of the periphery economies. His proposal for a “disciplinarian, minimalist political union” seems unlikely to attract support from either the Germans on the grounds of inadequacy, or the French and Italians on the grounds of requiring too much sovereignty to be surrendered. Varoufakis concludes “Nothing short of macro-economically significant institutional reforms will stabilise Europe. And only a pan-European democratic alliance of citizens can generate the groundswell needed for such reforms to take root.” The question of course is how to achieve this. Meanwhile, the economies in Europe continue to show recovery and the European Central Bank has affirmed their commitment to supportive policy, indeed indicating they would expand the programs if the environment so required.
Crossing the Atlantic we stay in the political realm, though surprisingly there is somewhat more encouraging news. A matter of days prior to existing funding arrangements expiring, a compromise was reached that means another government shutdown has been avoided and will be until after there is a new President in the White House. This agreement also included an extension to the debt ceiling, taking away a tool that in the recent past has been central to the game of brinkmanship that passes for governing in the United States these days. Whilst this agreement is welcome, unfortunately there is no basis for assuming that the characteristic dysfunction and gridlock in Washington is going away. Rather, as we enter the home straight that is the final year of the presidential election campaign, we should expect that the battle lines in America, different though they are, become more entrenched.
There has been some confusion on the messaging coming with the recent decisions of the Federal Reserve not to lift interest rates. Whilst the previous statement had made reference to ‘global economic and financial developments,’ that was no longer part of the language post the October meeting which again left rates at effectively 0%. Interpreting these statements and the comments from key voting members of the committee that sets rates involves art and science, and right now neither seems to be all that effective. Opinion remains split between those who insist that rates should have moved up long ago, and those who say there is still no fundamental reason to do so. With one last meeting for the year in December, it is now seen as a slightly better than even chance that the lift-off moment will arrive, if not we will still be discussing Fed policy until at least March next year. Whilst this occupies the mind of market observers, the reality is that the trajectory of rates post lift-off is likely to be very shallow, meaning interest rates will stay at historically low levels for many years to come.
Looking through the headline growth numbers on China’s economy provides an important insight into the status of their transition. GDP Growth for Q3 came in at 6.9% which was slightly better than expectations, and the result was led by growth in the services sector which accelerated slightly to 8.6%. Elsewhere, growth in the manufacturing sector slowed to a rate of 5.8% rather than 6% in the second quarter. Similarly, fixed asset investment continued to grow but at a slower rate of 10.3%; however the household sector remained robust in the face of the equity market collapse. Retail sales grew at 10.9% for the year ending September and disposable income rising at annual rate of 10.2% was a strong outcome. These figures should provide some comfort to those attendees at the World Bank-IMF conference we discussed earlier, though as we have stated regularly there are China sceptics who will remain that way no matter the data. Looking ahead, we have seen regular supportive policy moves in the form of interest rate reductions and lower reserve requirements for banks, both of which will stimulate future activity and underpin ongoing “medium-high economic growth.”
That last phrase is from the communique of the recent gathering of China’s Central Committee which agreed on their 13th five-year plan covering 2016 to 2020. Formal GDP targets won’t be announced until the new year though we should expect that it will start with a 6. Premier Li Keqiang has been quoted recently saying that growth of around 6.5% would be consistent with the leadership’s goals of doubling both the GDP and per capita income between 2010 and 2020. It is important also to remember that: “Even as the pace of growth slows, China is contributing more to the world economy than ever before, because its GDP today is US$10.3 trillion, up from just US$2.3 trillion in 2005. Simple arithmetic shows that US$10.3 trillion growing at 6% or 7% produces much bigger numbers than 10% growth starting from a base that is almost five times smaller. This base effect also means that China will continue to absorb more natural resources than ever before, despite its diminishing growth prospects.”3
When we look at the state of the Australian economy, we need of course to analyse our own transition from the earlier stages of the mining boom to the current drivers of growth. A good proxy for that thinking is to look at the health of the individual states, and in particular the distinction between those that benefited from the historically high capital investment and those that have now assumed the mantle of growth. What will become important is that the growth generated now by primarily New South Wales but also Victoria becomes broadly based, rather than concentrated in the residential housing sector which is starting to show signs of cooling. Pleasingly, there are some signs of exactly this emerging: “Firms, especially in the services sector, are reporting better business conditions, and with expectations of further interest rate cuts building and the new Prime Minister appearing to lift the national spirit, this momentum should continue.”4
Our own central bankers have judged that present conditions don’t at this stage warrant the rate cuts mentioned above, though many do expect there will be one or maybe two cuts of 0.25% to the cash rate in the first half of 2016. Governor Glenn Stevens encapsulated our current position in a recent speech: “First, we did not see the same excesses on the upswing as we did in other similar episodes. This has to put us in a better position to manage the inevitable down phase. Second, in the down phase we are still managing to grow. We are probably roughly halfway through the decline in resources sector capital spending now; the headwinds from that source are about as intense now as they are likely to get. We are still growing.”5 We remain moderately optimistic about the outlook for the Australian economy, and continue to see value in our investment markets.
1. Willem Buiter, et al., “Letter from Lima: Gloom, But No Doom” – Global Economics View – Citi Research. 13-Oct-15.
2. Yanis Varoufakis, “Schäuble’s Gathering Storm” – Project Syndicate. 23-Oct-15.
3. Anatole Kaletsky, “China is Not Collapsing” – Project Syndicate. 12-Oct-15.
4. ANZ Research, States and Territories Chartpack – Economic Insight Australia. 29-Oct-15.
5. Glenn Stevens, Speech – “The Path to Prosperity” Reserve Bank of Australia. 5-Nov-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 (ABN 33 711 661 027 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.