Economic and Investment Update - June 2014
by Mark Causer
The combination of reasonable growth and declining bond yields continues to provide tailwinds for equities. US economic data seems to be improving after a weak start to 2014, while Japan appears to be coping with the sales tax increase. The European recovery remains broadly intact and China continues to go through change.
Employment numbers in the U.S rose by 217,000 in May and the unemployment rate remained steady at 6.3%1. The growth of employment in the US has been particularly strong, following unfavourable weather conditions which weighed on results earlier in the year.
Retail sales have expanded at 10% annualised over the past 3 months2. Spending has also been supported by strong gains in the household balance sheet. Household wealth in the US now stands at US $81.8 trillion, driven by a US$758 billion gain in home values and a US$361 billion gain in equity values in the March quarter3. This is a significant increase from 5 years ago when household wealth stood at US$55.6 trillion.
Source: Advisor Perspectives
The Japanese economy’s annualised growth rate for the first quarter of 2014 was revised up to 6.7%4. There were a number of forces at play which contributed to Japans growth rate. Most notably, Prime Minister Shinzo Abe increased Japan’s sales tax from 5% to 8%. It will rise again to 10% in October 2015. The stepped increases are aimed at covering rising social welfare costs linked to Japan’s ageing population. Due to the proposed tax increase, there was rushed demand of consumer goods just before the increase took place.
In addition, over the last quarter business investment also rose noticeably, reflecting a pickup in sentiment. On the other hand, overseas demand contributed negatively to Japan’s GDP numbers. This was due to the increase in imports compared to exports, again attributed to a surge in demand before the sales tax rise4.
It is expected that GDP rates will return to the recent trend of a more tepid recovery due to the following: a strengthening of domestic demand through economic measures, such as public investment, tax cuts for enterprises and support for households, and an improvement in income environments in households mainly due to a rise in summer bonuses4.
The European recovery remains intact but got off to a disappointing start in the first three months of 2014, when GDP rose by just 0.3% across the European Union (EU)5. Forecasts in early May from the European Commission suggested that the recovery would be modest this year but gather momentum in 2015. GDP in the EU is expected to expand by 1.6% this year and 2.0% in 20155. As it is expected that this year’s growth will remain low, the argument for further monetary stimulus from the European Central Bank is maintained.
It is expected that the driving force behind the euro zone’s recovery this year will be Germany, which makes up nearly 30% of the collective output, and which is predicted to grow by 1.8%5. Growth projections are based on expectations that the three other large economies, France, Italy and Spain improve. One sign of renewed confidence is that the Spanish government has commenced repaying €1.3bn of its €42bn EU bailout package earlier than planned.
The consensus view is that the euro-zone recovery will not be strong enough this year to make much of an impact on unemployment, forecast to fall from 12.0% last year to 11.8% in 2014 though expected to drop more in 2015, to 11.4%5.
China’s economic growth is gradually slowing as the structural transformation of the economy continues. China’s growth in 2013 was relatively stable, partly due to the governments’ growth support measures. However, recent growth rates have been below the levels observed over the past decade as drivers of economic growth continue to shift from manufacturing to services on the supply side, and from investment to consumption on the demand side, while measures to rein in the rapid accumulation of credit have come into force6. Growth in China is expected to decrease marginally to 7.6% in 2014 and 7.5% in 2015, from 7.7% in 20136.
Fiscal and financial sector reforms are needed to ensure financial stability in the medium term. This involves two areas including: managing the process of rapid credit growth, including the less well-regulated shadow banking system; as well as the gradual and orderly deleveraging of large local government debt6.
In May, the Australian equity market was up 0.65%, lagging behind the developed economy equity markets of the rest of the world. Cyclical sectors dropped due to concerns out of the Budget and weaker domestic economic indicators, as well as declining iron ore prices. The Australian market index has returned 2.76% for the quarter, delivering a solid 1 year return of 16.45%, with a number of the active fund managers outperforming this figure.
Uncertainty in relation to medical payments, university fee deregulation and changes to fuel indexation and pension indexation is currently the focus of markets. Consumer confidence has also taken a hit with declining commodity prices, in particular iron ore declining 30% so far in 2014.
Spot Iron Ore Price, $US per tonne, since July 2013
Source: Business Insider
With regard to the developed economies, global equity markets recovered in May with the broader index returning 2.30% and the US recording new highs. In addition, Japan generated positive returns after four consecutive monthly declines. European markets were also up. International share markets as a whole continue to provide strong returns to portfolios, with the index returning over 22% for the year (for Australian investors). The best performing global sectors in May were healthcare, media, real estate and IT.
Source: Yahoo Finance
The emerging economies did better still, with the index returning 2.86% for May, which equates to 4.62% for the quarter. So far in 2014, strong performance has been achieved in India (16.6%), Indonesia (21.3%), Turkey (21.6%) and the Philippines (15.6%).
After a very strong April performance, Australian listed property was flat in May. The asset class has returned almost 7% for the year to date. Easy financial conditions and low interest rates across global economies have generated a thirst for yield and supported investment in property.
With regard to residential property, the price index for the average of Australia’s eight capital cities rose 1.7% in the March quarter. Property price growth over this period in Sydney was 2.3%. After outperforming in 2013, residential property growth has slowed in broad terms in 2014. However, the property market is stock specific and there are some big deals taking place at the moment. As an example, the Aqua residential development in Sydney’s Bondi Junction sold out on its launch day in only 4 hours. This included 129 apartments valued at more than $130 million.
Cash and Fixed Interest
Again, the RBA left interest rates on hold at 2.5% in their June meeting. The Australian dollar was fairly steady in May and continues to hover around the 0.94 USD mark at the time of writing.
Fixed interest funds have had a decent 6 months compared to recent history, with the index returning 4.38%, bringing the one year return to almost 5%. However, bond yields continue to decline globally, reflecting the belief that the easy policies adopted by central banks in the major developed countries will continue for some time. The US Federal Reserve has indicated that it is in no hurry to tighten policy.
1. The Wall Street Journal: Market Watch – Economic Report June 2014
2. Van Eyk Investment Outlook Report – June 2014
3. Financial Times, Harding, Robin – June 2014
4. The Japan Research Institute: Monthly Report April 2014
5. The Economist: Taking Europe’s Pulse – May 2014
6. The World Bank: China Economic Update – June 2014
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