11 Aug Monthly Economic & Investment Market Commentary July 2016
Pleasingly there has been a reasonably sustained rally in most asset classes over the last couple of months, and this is reflected in somewhat reduced long term return expectations. Importantly, in Australian Equities the Financials sector has participated in this move, compared with the recent past when it has been somewhat of a laggard. Listed Property has been a very strong performer over the last couple of years, and is now in the Fully Priced zone
As usual, there is an enormous amount of material this month that warrants discussion in a portfolio management context, including significant developments and ongoing issues in the areas of geopolitics, domestic politics in a range of countries, the economy and of course investment markets.
UNITED KINGDOM AND EUROPE
We are now more than a month on from the vote that determined the United Kingdom wants to leave the European Union. A new Prime Minster in Downing Street has made it very clear that “Brexit means Brexit” – though what that will actually look like remains very unclear and in all likelihood we are years away from knowing. An assessment of the various negotiating positions between the U.K. on one side of the table and the EU and the 27 remaining member nations on the other is an extraordinarily complex task. It seems clear that Germany, amongst others, will insist that the U.K. accepts free movement of labour in exchange for continued access to the single market in goods and services. It remains unclear how this most fundamental impasse can be negotiated, before moving on to the vast array of other country specific positions. “The result is a complex patchwork of priorities – from fishing to shipping, an insistence on free movement to the sovereignty of Gibraltar – that may run counter to what the U.K. wants to achieve and that it will have to seek to satisfy if May is to meet her commitment of making a success of Britain’s withdrawal from the EU.”1
While this uncertainty is likely to linger, it is worth observing that after the initial volatile reaction, markets in both Europe and around the world have for now largely moved on from this episode.
All eyes are of course on the presidential election in the United States, and both major parties have now held their respective conventions and formally nominated their candidates for President. In the weeks following there has been a major shift in the prediction models about the likely outcome, though with the election still about 100 days away, it would of course be foolish to place undue confidence in the current assessment. Nonetheless, a series of well documented gaffes and mistakes on the campaign trail seem to eventually have caught up with Republican nominee Donald Trump. A range of statistical models now puts the likelihood that the United States will have its first female president at about 85%.
Importantly, there is a rising tide of Republicans that are disavowing their own party’s candidate, including most notably a group of 50 former senior national security and foreign policy advisers, who in an open letter wrote: “Mr. Trump has demonstrated repeatedly that he has little understanding of America’s vital national interests, its complex diplomatic challenges, its indispensable alliances, and the democratic values on which U.S. foreign policy must be based. At the same time, he persistently compliments our adversaries and threatens our allies and friends. Unlike previous Presidents who had limited experience in foreign affairs, Mr. Trump has shown no interest in educating himself. He continues to display an alarming ignorance of basic facts of contemporary international politics.”2 They conclude by affirming their view that if elected Trump would be the most reckless President in American history.
Leaving politics aside let us consider the U.S. economy where growth remains weak, as evidenced by the latest reading on GDP which showed that for the year ending June the economy grew at just 1.2%. That said, jobs growth remains robust and the assessment of the market is that there is a 40% chance that the Federal Reserve will hike interest rates by the end of the calendar year.
The retiring Governor of the Reserve Bank of Australia used the occasion of his final public speech to look back on the period of his tenure: “In summary then, we faced a more volatile world than the one of the ‘great stability’ of the previous period. It was a world characterised by massive swings in our terms of trade, and a very serious international financial crisis followed by a deep global recession, not to mention the effects of the adoption of ‘non-conventional’ policies in the major jurisdictions. And yet the Australian economy avoided a major downturn and turned in a performance on economic activity characterised by no more, and on some metrics slightly less, volatility. We have achieved the inflation target and with an average unemployment rate of between 5 and 6 per cent. Had anyone, a decade ago, accurately forecast all the international events and simultaneously predicted that things would turn out in Australia as they have, they would not have been believed. But here we are.”3
Looking ahead, and importantly in the context of the recent decision from Standard and Poors to move Australia to a negative outlook on our AAA credit rating, Glenn Stevens went on to say: “Many difficult choices will need to be made along the path of budgetary adjustment. At present, general public debate starts with commitment to the need for reform and for putting public finances on a sustainable medium-term track. But when specific ideas are proposed that will actually make a difference over the medium to long term, the conversation quickly shifts to rather narrow notions of ‘fairness’, people look to their own positions, the interest groups all come out and the specific proposals often run into the sand. If we think this rather other-worldly discussion will not have to give way to a more hard-nosed conversation, we are kidding ourselves. That will occur should there be a moment of crisis, but it would be better if it occurred before then.”3
These two quotes summarise very succinctly the position of the Australian economy and by extension the long term prospects for our investment markets. We have distinct advantages over much of the Developed World including not least the relatively low level of public debt. This affords the capacity for focused government policy to borrow very cheaply and invest in assets that support productive capacity in the economy and provide a long term economic benefit. The incoming Governor of the RBA, who is the long-serving current deputy, has further room to move on interest rates should that be thought necessary, and strong support from our other regulators including the bank’s supervisor – the Australian Prudential Regulation Authority. Our own political landscape is of course not without its shortcomings and it remains to be seen if effective fiscal policy can make it through an increasingly fractious parliament.
Given all this we do continue to see, as outlined on the following page, that with relatively modest and undemanding assumptions, that the expected returns from Australian Equities are attractive firstly on an absolute basis when compared to risk free returns. Secondly, they are also attractive on a relative basis to the other major regions that in our assessment come with higher attendant risks than our own outlook. For that reason we continue to expect that the overweight stance with regard to Australian Equities will be a feature of your portfolio for some time to come.
- Alan Crawford, “Brexit Red Lines Drafted by EU-27 as U.K. Plans Its Strategy” – Bloomberg, 10-Aug-16.
- “ALetter From G.O.P. National Security Officials Opposing Donald Trump” – New York Times, 8-Aug-16.
- Glenn Stevens, “Address to the Anika Foundation Luncheon” – Reserve Bank of Australia, 10-Aug-16.
DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 76 821 231 362. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management (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.