Caton's Corner Chris Caton | BT Chief Economist July 1, 2015
Share markets rose again in April, with the ASX up by 3.3% and the S&P500 index up by 0.3%. This is the first consecutive two months of gains for the domestic market since February 2015. The two indexes are now up by 10.3% and 12.9% respectively from their early-February troughs. For the year to date, the ASX200 is still down, by 0.8%, while the S&P has risen by 1%.
The US share market has now gone for 2612 days without a “bear market” fall of 20% or more. This makes it the second-longest bull market ever, surpassed only by the rise from November 1990 until the tech bust in late-March 2000. The total price gain of 205% puts it in just fifth place, however; the 1990-2000 episode saw a price rise of 417%.
As I noted last month, this recovery shouldn’t have come as a complete surprise. The weakness of markets in the New Year reflected an overly pessimistic view of the outlook for the global economy. 2016 looks like being yet another year of stubbornly slow growth, but that is a long way from the near-recession outlook apparently priced into markets early in the year.
What is remarkable is the almost simultaneous turn in so many markets—the US dollar, the Australian dollar, credit spreads, the Baltic dry index, oil prices and iron ore prices to name just a few - in late-January, early-February, and the subsequent V-shape in so many markets. Having been confident that a turn would come, I now find myself wondering if markets haven’t recovered too quickly!
There were no major developments on the monetary policy front in April. The ECB eased further, while Japan sat pat. The US Federal Reserve now appears to be more relaxed about global economic and market risks. Indeed, they are no longer described as “risks” but only as areas that will be “closely monitored”. The post-meeting statement also highlighted the split between slowing domestic output growth and a steadily improving labour market. The Committee left the door open for a June rate rise without suggesting that it was particularly likely to occur.
The FOMC was correct to note the different messages being sent by the output and labour-market data. Late in April, it was announced that GDP had increased at an annual rate of just 0.5% in the first quarter of this year, and by just 2% in the past twelve months. Meanwhile, employment has also grown by 2% in the past year, with the unemployment rate on a plateau of 5% for the past six months. The Fed continues to be concerned that inflation is too low, with the PCE deflator up by just 0.8% in the year to March and the core index, which strips out food and energy prices, up by 1.6%. The Fed officially targets the former, but probably pays more attention to the latter in the short term; its target (not a ceiling) is 2%.
The Chinese economy appears to be growing at a moderate rate, with some of the effects of a considerable amount of stimulus still in the pipeline.
Meanwhile back in Oz
The unemployment rate fell for the second month in succession, from 5.8% to 5.7%, the lowest it has been since July 2013. Employment increased moderately.
We also got a remarkably low CPI inflation result for the March quarter. The headline index fell by 0.2%, to be up by just 1.3% in the past year, while “underlying” inflation, which strips out the influence of volatile items (such as oil prices at present) came in at a record low of just 1.5% in the past year. Since the RBA’s target range is 2-3% (on average, over the course of the cycle), this certainly gives it room to cut rates further should it wish to do so. Last month I wrote: “(t)here is one other factor that could precipitate a further rate cut; suppose that we get a surprisingly low CPI inflation result at end-April. A May rate cut cannot be ruled out completely, although bear in mind that the first Tuesday in May has already been reserved for a different major economic event, namely the rescheduled Budget”.
Markets are currently pricing in a bit a 58% chance of a cut on 3 May (up from 16% prior to the release of the CPI), and they may turn out to be right. On the basis that one doesn’t change one’s forecast unless convinced beyond reasonable doubt, I think the RBA will remain on hold. In a recent speech, Governor Glenn Stevens suggested that the potency of monetary policy wanes when rates get very low, and the Bank would probably prefer to hang on to whatever firepower it has left just in case it is needed in the event of some future (global?) shock to the economy. The RBA may also consider the apparent re-ignition of house prices in April (up by almost 2% after a weak February/March).
My view is thus still that the RBA will keep rates on hold for the foreseeable future.
My end-of-year forecast for the ASX200 remains at 5400, although I am beginning to regret having cut it from 5500 at end-February. I still look for the currency to give up some of its recent strength, which has come about because the US dollar has weakened and the iron ore price has increased.
The Budget etc
The 2016-17 Budget will be brought down this Tuesday, 3 May, a week earlier than originally scheduled. This has come about because the Government has opted for a double-dissolution election on 2 July, and it is necessary to get some of the Budget formalities out of the way before the Government goes into pre-election caretaker mode.
The Budget will thus also serve, in part, as a pre-election document, although it is unlikely to contain many “sweeteners” of the type often found in an election-year Budget; there just isn’t room.
The usual process of leaking suggests that there will be some infrastructure initiatives in the Budget (laudably so), along with some tightening of superannuation tax concessions for high-income earners (also laudable), but no change to negative gearing. There will also apparently be a minor income-tax cut, bruited as a partial offset to “bracket creep”. The latter, incidentally, has to be the most exaggerated fiscal evil since talk radio decided that government debt was a massive burden on the Australian people.
The Budget will also project an eventual return to surplus, although this projection may turn out to be “too good to be true”, since it will rely on the squeeze being applied by the Federal Government on the State governments in the areas of health and education payments.
The economic forecasts in the budget are the responsibility of the Government, although obviously they take advice from the Treasury and Department of Finance. But because the election will be called almost immediately, those two departments are the responsible for the PEFO (the Pre-election Economic and Fiscal Outlook). In the past, there has always been a decent interval of time between the Budget and the PEFO, so any major differences can be rationalised, but this won’t be the case on this occasion. The implication would seem to be that the forecasts on Budget night will effectively be those of the public servants.
Chris Caton Chief Economist
The views expressed in this article are the author’s alone. They should not be otherwise attributed.