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Quarterly Market Outlook April 2016
1. Presenter - Brian Nash
Director/Authorised Representative
Merlea Investments Pty Ltd
Australian Financial Services Licensee No. 226415
Tepid global growth gets markets off to a volatile start
2. Disclaimer
This presentation has been prepared for the general
information of investors and not having regard to any
particular person’s investment objectives, financial
situation and particular needs. Accordingly, no recipient
should rely on any recommendations (whether expressed
or implied) contained in this document without having
obtained specific advice from their adviser. Brian W. Nash &
Merlea Investments make no representation, give no
warranty and do not accept responsibility for the accuracy
or completeness of any recommendation, information or
advice contained herein and Brian W. Nash & Merlea
Investments will not be liable to the recipient or any other
persons in contract, in tort for negligence or otherwise for
any loss or damage arising as a result of the recipient or
any other person acting or refraining from acting in
reliance on any recommendation, information or advice
herein except insofar as any statutory liability cannot be
excluded.
3. Overview: Tepid Global Growth
Continued concerns about China’s outlook and the trajectory of the global economy weighed on sentiment
at the start of 2016, but the tone reversed sharply amid the steady U.S. economy and a perceived easing
in the Fed’s tightening posture. We expect global economic growth to stabilise as 2016 progresses, with a
possible upside surprise in inflation.
Fed: Federal Reserve. DM: developed market. EM: emerging market. Past performance is no guarantee of future results
4. Mid-Quarter Reversal Marks Turbulent Start to 2016
A steep drop in global risk assets during the first few weeks set a risk-off tone for the quarter, as
investors rotated to government bonds and gold. A subsequent rally in global equities and commodities
during the final weeks of Q1 pushed most categories into positive territory for 2016, though more
defensive assets have still fared better on a one-year basis.
The table shows the change in fortunes of certain asset classes so far this year.
5. After Extended Drop, Global Assets Posted
The worst performers in 2015—emerging-market equities, commodities, and non-U.S. currencies—suffered further
losses in the first several weeks of 2016 before rebounding to finish with Q1 gains. Over the past few quarters, the
returns of oil prices, high-yield bonds, and EM equities have been highly correlated, leaving Treasuries as a key
diversifier.
LEFT: DM and EM currencies are equal-weighted averages of MSCI EAFE and MSCI EM countries’ currencies. Source: Bloomberg Finance L.P., Fidelity Investments (AART), as of 3/31/16. RIGHT:
Correlations use daily returns. EM = MSCI EM Index; Treasuries = Barclays Treasury Index; High Yield = Bank of America Merrill Lynch High Yield Master II Index; Oil = WTI Oil price. Source: Bloomberg
Finance L.P., Fidelity Investments (AART), as of 3/31/16.
6. Sovereign Bond Yields Drop Even Further;
Weak global growth and easier monetary postures by many of the world’s largest central banks pushed
down government bond yields during Q1. Negative policy rates in Japan and the Eurozone helped push
bond yields into negative territory for some countries, while U.S. 10-year yields remained relatively high
compared with many other advanced economies. Yield increases going forward may be gradual.
Source: Haver Analytics, Fidelity Investments (AART), as of 3/31/16.
8. Business Cycle: Slow Backdrop, Possible Global Bottoming
Global economic growth remains tepid, as China and several other emerging markets, such as Brazil, face
recessionary pressures. Most of the developed world remains in a slow expansion, in either a mature stage of
mid-cycle or earlier innings of late cycle. We expect the global environment to be stable in 2016, albeit at an
overall subdued pace of growth.
Time to pay attention to inflation?
U.S. stocks: After initial wobble, most
categories turn positive.
International stocks and global assets:
Emerging markets, gold outperform
Bonds: Widespread gains in Q1
Four themes
9. Global Trade and Industrial Recession May Be Ebbing
Faltering growth and excess manufacturing capacity in China and other emerging markets helped push the
global economy into a trade recession in 2015. Leading indicators of global manufacturing activity—including
the difference between new orders and inventories—show incipient signs that global trade and industrial
activity may have bottomed.
LEFT: Export value in USD, adjusted for changes in currency. Source: International Monetary Fund, Haver Analytics, Fidelity Investments (AART), as of 12/31/15. RIGHT: Manufacturing bullwhip =
new orders PMI less inventories PMI. Includes PMIs from 31 countries. Source: Markit, Fidelity Investments (AART), as of 3/31/16.
Change (Year-over-Year)
Percentage of Countries with Bullwhip Above zero
10. China Key to Global Outlook: Any Global Stabilisation Would Benefit Exporters
After a multi-year credit and investment boom, China’s economy faces massive industrial overcapacity and
an overleveraged corporate sector. The effectiveness of monetary easing is blunted by waning loan demand
and the need for greater structural adjustments, but the policy emphasis on stability and fiscal stimulus
makes near-term stabilisation the most likely scenario. If China and the global economy can find their
footing, the headwinds facing exporters will likely abate.
Exports exclude services exports. Commodities include agricultural, fuel, and mining products. Source: International Monetary Fund, World Trade Organization, Official Country Statistics, Haver Analytics, Fidelity Investments
(AART), as of 12/31/14
11. Global Easing Continued but Negative Rates Show Limits
Five major central banks, including the BOJ and ECB, have enacted negative policy rates in an effort to
boost inflation and weaken their currencies, but all these currencies strengthened against the dollar over
the past year. Negative rates may not support (and may even run counter to) their intended goals, an
example of the limits of monetary policy.
LEJPY: Japanese yen; EUR: euro; SEK: Swedish krona; DKK: Danish krone; CHF: Swiss franc. Currencies are 3-day moving averages. Source: Federal Reserve Board, Haver Analytics, Fidelity Investments (AART), as of 3/31/16.FT: NPL = Non-performing loan. Source: China
Banking Regulatory Commission, China National Bureau of Statistics, Haver Analytics, Fidelity Investments (AART),
13. Inflation Impulse is Typically Key to Late-Cycle Transition
The transition from a mid-cycle phase to a late-cycle phase typically involves a pickup in inflationary
pressures, with commodity prices and wages tending to accelerate. These rising input costs pressure
corporate earnings by causing profit margins to decline and also lead to tighter credit conditions and
more restrictive monetary policy.
Fidelity Investments proprietary analysis of historical commodity performance, using data from BP Statistical Review of World Energy, U.S.
Department of Agriculture, U.S. Geological Survey, and U.S. Foreign Agricultural Service. Wages = Average Hourly Earnings. Source: Bureau of La0ur Statistics, Haver Analytics, Fidelity
Investments (AART), as of 11/30/15.
15. Global “Base Effect” Likely to Lift Inflation in 2016
After steep plunges in commodity prices and inflation, a lower base has been established. If global activity
stabilises in 2016, the “base effect” could push up global inflation even without a powerful growth or
commodity rebound. With core inflation firm in the U.S. (and other DMs), U.S. headline inflation will likely
rise over the course of the year even if oil prices remain low.
CHART: *Scenarios assume core CPI and food cost growth rates remain constant and vary only by the cost of oil each month. Source: Bureau of Labour
Statistics, Haver Analytics, Fidelity Investments (AART), as of 11/30/15. TABLE: Data shown are year over year. Japan low: April 2015. Eurozone low:
March 2015. Source: Japan Ministry of Internal Affairs and Communications, Eurostat, Haver Analytics
16. U.S. Inflation Indicators May Be Starting to Accelerate
Historically, the U.S. has experienced a sustained broad-based acceleration in inflation pressures as the
business cycle matures, and it eventually peaks during the late cycle. While inflation has remained muted
since the financial crisis—a far cry from the high levels seen in the late 1960s and 1970s—recent data
suggest an uptick has occurred across several indicators.
Source: Markit, Haver Analytics, Fidelity IShaded areas represent U.S. recession as defined by National Bureau of Economic Research (NBER). Fidelity Investments proprietary analysis of historical commodity
performance, consumer prices, business prices, wages and currency. The U.S. Inflation Diffusion Index compares the performance of commodity prices, consumer prices, business prices, wages and currency
over the past year to their average performance over the past several years. Prices appreciating faster over the past year are considered to be inflationary. Source: Bureau of Labor Statistics, Federal Reserve,
Bureau of Economic Analysis, BP Statistical Review of World Energy, U.S. Department of Agriculture, U.S. Geological Survey, and U.S. Foreign Agricultural Service, Haver Analytics,nvestments(AART), as of
12/31/15.
17. Outlook: Market Assessment
Merlea believes that any stabilisation in China should be supportive of risk assets.
However, at this point in the cycle, there may be more limited upside for returns,
and therefore smaller bets are warranted.
Asset Allocation Considerations Potential Risks
Less reliable relative asset performance patterns
generally merit smaller cyclical tilts.
Any stabilisation in China may provide support to risk
assets
The potential for upside inflation surprises is not priced
in.
Maintain expectation of higher volatility due
to unconventional monetary policies and
other factors
At this point in the cycle, risks may be
asymmetrical, with generally more limited
upside for returns.
19. Consumer Buoys Backdrop: Low Odds of U.S. Recession
With labour markets continuing to tighten and inflation remaining low, U.S. consumers have enjoyed solid real
(inflation-adjusted) income gains and have experienced a steady rise in future real wage expectations. Although
rising savings rates have blunted the pace of consumption growth, the large, sturdy U.S. household sector has
kept the U.S. expansion in tact.
SourceShaded area represents U.S. recession as defined by National Bureau of Economic Research (NBER). Source: University of Michigan, Department of Labor,
NBER, Haver Analytics, Fidelity Investments (AART), as of 3/31/16.:
20. A Mix of Mid- and Late-Cycle Dynamics in the
During the late-cycle phase, credit lending standards have historically tightened and housing activity has
typically moderated. Recently, banks have tightened business credit but continue to ease mortgage lending,
and the housing sector has remained a positive support for U.S. domestic growth.
LEFT: Source: Census Bureau, National Association of Realtors, Haver Analytics, Fidelity Investments (AART), as of 2/29/16. RIGHT: Source:
Federal Reserve, Haver Analytics, Fidelity Investments (AART), as of 2/1/16.
21. Stocks Fairly Valued, Even if Inflation Ticks Up
U.S. P/E ratios are somewhat above their long-term historical averages, but we believe over the long term that
stocks will sustain a valuation level closer to the average of the past 20 years. Valuations have historically had a
negative relationship with inflation, but there is room for inflation to rise from today’s low levels and still be
generally supportive of high P/Es.
Past performance is no guarantee of future results. Price and five-year peak earnings are adjusted for inflation. Source: Standard & Poor’s, Bureau
of Labor Statistics, Haver Analytics, Fidelity Investments (AART), as of 3/31/16.
23. China: Three challenges – Economy, Markets and Currency
GDP growth versus the Premier Li Index 1-year lending rate and RRR
Source: Bloomberg. GDP data to 31 December 2015. Li Ke Qiang Index data to 30 November 2015. RRR
and 1-year lending rate to 31 December 2015.
China has three challenges:
1) A slowing economy; 2) Equity market volatility, and 3) Capital outflow and currency depreciation.
The Chinese economy is clearly slowing – but this is consistent with medium-term plans.
Average GDP growth of 6.5% required to reach goal of doubling China’s real GDP by 2020.
Further stimulus measures will be needed – this should include ‘traditional monetary policy’ tools –
interest rate cuts and RRR reductions - and targeted fiscal policy.
24. China: Asset market volatility
Source: Bloomberg. Data to 25 January 2016 for Shanghai Composite. Property prices to 31 December 2015
Chinese equity markets have traded with volatility due to margin financing, valuations, flighty retail investment and changing regulation.
But China’s equity market is not a real ‘market’ – highly regulated and dominated by flighty retail flows and not reflective of the broader
economy. March quarterly data came out (a bare fortnight after the end of the quarter, as usual) and GDP growth was 6.7 per cent, which
is smack in the middle of the Government’s “target band”, if you believe it, which we don’t. But it kind of doesn’t matter what we believe
and what the reality is – if the statisticians announce that Chinese growth is 6.7 per cent, then that’s what it is.
Industrial production rebounded from 5.4 to 6.8 per cent and retail sales grew 10.5 per cent. This indicates no big, unexpected Chinese
slowdown. This all came after the March PMI which increased strongly – by 1.2 points to 50.2, well ahead of market expectations –
although the starting point for 2016 is lower than previous years, as shown in the below charts
25. Emerging-Market and the gold price
In a reversal of a multi-year trend, emerging markets were the strongest non-U.S. equity category in Q1. Also
running counter to a longstanding narrative, a weakening dollar provided a boost to returns for U.S.-based
investors. Gold benefited from the risk-off market environment and global policy easing.
EM: emerging markets. LC: local currency. All returns are gross in U.S. dollars unless otherwise noted. Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important
index information. Index returns represented by: Canada – MSCI Canada Index; Commodities – S&P GSCI Commodities Index; EAFE – MSCI Europe, Australasia, Far East Index; EAFE Small Cap – MSCI EAFE Small Cap Index; EM Asia – MSCI Emerging Markets Asia
Index; EMEA (Europe, Middle East, and Africa) – MSCI EM EMEA Index; Emerging Markets (EM) – MSCI EM Index; Europe – MSCI Europe Index; Gold – Gold Bullion Price, LBMA PM Fix; Japan – MSCI Japan Index; Latin America – MSCI EM Latin America Index.
Source:
26. Emerging-Market
Since 2012, developed-market equity performance has been boosted by multiple expansion, but
negative earnings growth and weaker currencies have detracted from returns. More realistic earnings
expectations and the prospect of more stable currencies may support developed-market performance on
a cyclical basis.
Chart represents MSCI EAFE returns. Source: FactSet, MSCI, Fidelity Investments (AART), as of 3/31/16. Chart as of 12/31/15.
27. Selective Opportunities in Emerging Markets
While many emerging-market countries face cyclical challenges, we believe that they have strong secular growth
prospects and that, by 2034, EMs will make up half of the world’s 12 largest economies. Overall, we expect
growth of emerging countries to outpace that of developed markets, providing a favourable secular backdrop for
EM assets.
Past performance is no guarantee of future results. It is not possible to invest directly in an index. All indices are unmanaged. Please see appendix for important index information. EAFE: Europe, Australasia, Far East. EM: emerging market. Price-to-earnings (P/E) ratio (or multiple): stock price
divided by earnings per share, which indicates how much investors are paying for a company’s earnings power. EM – MSCI Emerging Markets Index; EAFE ex-U.S. – MSCI EAFE ex-U.S. Index; U.S. – MSCI USA Index. LEFT: Five-year peak earnings are adjusted for inflation. Source: FactSet,
countries’ statistical organizations, Haver Analytics, Fidelity Investments (AART), as of 3/31/16. RIGHT: Forward P/E valuations are price divided by next-twelve-months earnings estimates. Source
29. EU: Europe is deeply in trouble
Recovery in the Eurozone masks widely diverging developments in individual countries; Northern Europe is
doing relatively fine, but there is mass unemployment in Southern Europe, with public finances far from stable.
The Greek problem is still not solved, growing discontent among the population, an ageing population, but no
warm welcome for immigrants, and the danger of a Brexit………..
30. EU: Inflation ticked up, reinforcing ECB’s plan
Headline inflation into negative territory in January 2015 due to weak economy and sharply lower oil price and has
struggled to recover since then. Headline inflation was 0.1%/yr for December and Core inflation was 0.9%/yr.
ECB Draghi cut the deposit rate to -0.3% in December and extended its Asset Purchase Program by six-months to
March 2017 to fight deflation. Still room for further stimulus in 2016.
Source: Bloomberg. DSource: Bloomberg, Economist.com. Data as at 22 February 2016
Negative yields – extensive and deep
31. EU: The immigration challenge
It could have been a blessing in disguise, but it wasn’t……
•In a shrinking continent, the inflow of immigrants basically is a good thing
•Refugee crisis: mass immigration leads to wide divisions between countries ==> Cooperation under pressure
•The response to the threat of terror and the challenge of immigration is potentially more damaging than the
challenges themselves
•A gradual demolishing of Schengen would be the first step in European disintegration
32. Brexit: negative for everyone
Bad for Europe
•Loss of a prominent country with a large economy
•Loss of a pro free trade partner
•Loss of face for the EU
•Loss of a Member State that is able to project power
•Who’s next?
But even worse for the UK
•Exit EU = exit from Europe’s Internal Market
•Long period of uncertainty: foreign investors will stay at the
sideline
•Many banks and other companies will move to the continent
•New Scottish referendum
33. Global economies summary
Continued concerns about China's outlook and the trajectory of the global economy weighed on
sentiment at the start of 2016, causing a steep drop in global risk assets during the first few
weeks. Government bonds and gold benefited from the risk-off environment.
Global policy easing continued during Q1. The Bank of Japan and European Central Bank eased
monetary conditions, although their negative policy rates did not weaken their currencies and
may be an example of the limits of monetary policy.
Any stabilisation in the global economy may support risk assets, and the potential for upside
inflation surprises was not reflected in prices at quarter end.
However, the tone reversed sharply mid-quarter amid the steady U.S. economy and easier
global monetary policy, including the Federal Reserve softening its rate-hiking stance.
The worst performers in 2015—emerging-market equities, commodities, and non-U.S.
currencies—suffered further losses in the first several weeks of 2016, before rebounding to
finish with Q1 gains.
We expect global economic stabilisation will provide favourable support for equities, but
elevated volatility is likely to continue. Inflation-resistant assets may offer protection against an
upside surprise.
35. Australia: Mining investment slowing, non-mining not recovering
Private capital expenditure intentions and actual
Mining investment is declining as expected. But non-mining investment is much weaker-than-expected.
The RBA has highlighted the reluctance of Australian companies to lower their expected rate of return on
investment. This seems at odds with low interest rate environment.
Non-mining capex is unlikely to rise sharply until expected rates of return are adjusted lower and there is
increased confidence in the outlook.
Source: ABS. Data to November 2015. The estimates are for 14/15 and 15/16
36. Australia: Economic growth rate below average and income growth
slightly positive
Australia probably derived more benefit from Chinese growth and industrialisation than any other nation on earth
and while resources exports are rising, they are at falling prices and don’t employ as many workers. Australia has
experienced sub-trend growth, declining real per capita incomes and rising unemployment since commodity prices
peaked.
Note: Real net national disposable income (NNDI) is real GDP adjusted for changes in the terms of trade, minus net factor income and transfers overseas, minus
depreciation. Growth in real net national disposable income per head`Unemployment rate
Source: ABS.
37. Australia: is relying on record-low interest rates and a (now) below
long-term-average Australian dollar to support economic growth
But non-mining investment is much weaker-than-expected. The RBA has highlighted the reluctance
of Australian companies to lower their expected rate of return on investment. This seems at odds
with low interest rate environment.
.
Source: ABS.
38. Australia: Could Australia be heading for a housing “bust”
Record-low interest rates stimulated a substantial rise in housing demand, housing prices and
(eventually) housing supply . Australia now has relatively high residential property prices (by international
standards) and very high levels of household debt. Overseas experience suggests that housing ‘busts’
occur when demand declines abruptly after an extended period of rapid growth in supply.
Sources: ABS; US Commerce Department; UK Office for National Statistics; Eurostat; CoreLogic; S&P;
Bank for International Settlements;.
Note: OECD average for household debt to income ratio based on a limited number of countries.
Source: International Monetary Fund, Australia: Selected Issues, Country Report No. 15/275 (September
2015), p. 4
39. Australian dollar continues to adjust, USD to strengthen
The fall in the A$ has had a substantial influence on the tourism and education sectors. The AUD has been
declining against a stronger USD as AU/US interest rate spreads narrow. Weaker commodity prices also weigh on
the AUD. Further depreciation is expected in 2016 – likely range around $US0.65-$US0.70. AUD Trade-Weighted
Index has been better supported – given weakness in RMB, JPY and EUR..
Note: The number of overseas student enrolments shown in the second chart exceeds the number of overseas students in Australia, since some students are enrolled in
more than one category (eg higher education and English language). ‘Travel-related services’ includes accommodation, transport and food services provided to
foreign students as well as tourists. Sources: ABS; Australian Department of Education and Training
40. Business confidence has improved in recent months while business conditions have improved and
remain at a higher level, albeit dipped in December. Conditions continue to be helped by AUD and
better economic conditions in NSW.
Has political leadership had a meaningful (positive) effect on
business and consumer confidence?
Source: National Australia Bank Monthly Business Survey; Westpac-Melbourne Institute.
41. Australia: Household and business services sectors are doing well
Note: ‘Goods’ sector includes manufacturing; electricity, gas, water & waste services; construction; transport, postal & warehousing; wholesale trade; and retail
trade. ‘Business services’ includes professional, scientific & technical services; finance & insurance; administration & support services; rental hiring and real estate
services; and information, media & telecommunications. ‘Household services’ includes accommodation & food services; education & training; health care & social
services; arts & recreation; & other services. Not included are agriculture, forestry & fishing; mining; and public administration & safety. Source: ABS.
Goods producing and distribution sectors (mining and non-mining) are struggling. Private sector
surveys present a broadly similar picture of goods-producing sectors –struggling- but
construction and services are doing well. Because the (growing) services sectors are more
labour-intensive than (struggling) goods-producing sectors, employment growth has picked up.
42. Australia: Household income is growing much more slowly
Household income is growing much more slowly than before the financial crisis and the peak in the terms of trade –
and households are saving more. Sustained low inflation gives the RBA ‘room’ to cut interest rates again if needed.
The RBA downgraded both growth and inflation forecasts in its November meeting. Underlying inflation is now
expected to be at the bottom of the target band till mid-2016 before returning to the mid-point.
Sources: ABS; Reserve Bank of Australia
43. Australia: History suggests it is easy to be pessimistic about the
future of agriculture
However, there are actually some signs of what could potentially be a long-term turnaround in Australian
agriculture:
Source: ABS. Note: Farmers’ “terms of trade” is the ratio of prices received by farmers to prices paid. (f)
Forecasts from ABARES Agricultural Commodities December 2015 Data to 30 September for trade partner
44. Australia: Sydney house price growth does look “crazy” – Debt
burden is rising, but repayments still affordable
House prices expensive – especially Sydney and Melbourne, but Sydney weaker at year end 2015
Demand coming from: Low interest rates, local investors, SMSF and foreign investors.
Household debt to income hitting new highs around 180% (revised).
But low interest rates mean repayments are still affordable – the stock is high, but the flow is affordable.
Source: Your Investment Property magazine, November 2015.
45. Asian countries will need to import a lot more food products over
the next 40 years – and Australia could supply some of that
Source: Verity Linehan, Sally Thorpe, Neil Andrews, Yeon Kim & Farah Beaini, Food Demand
to 2050: Opportunities for Australian Agriculture, Paper
presented to 42nd ABARES Outlook Conference, 6-7 March 2012; Australian Government,
Australia in the Asian Century White Paper, October 2012
46. Australia: Agriculture has been doing a better job of improving
productivity
Agriculture needs to attract more capital in order to take full advantage of the opportunities that
are ‘out there’.
Note: Productivity growth is calculated as the average for a five-year period compared with the average for the preceding five years, expressed as an annual rate.
’12 market sectors’ are agriculture, forestry & fishing; mining; manufacturing; utilities; construction; wholesale trade; retail trade; accommodation & food services;
transport, postal & warehousing services; information, media & telecommunications services; financial & insurance services; and art & recreation services; for which
productivity estimates are available back to 1989-90. ‘Multi-factor’ productivity is output per unit of labour and capital services input, but does not include land and
hence differs from the concept of ‘total factor productivity’ used by ABARES researchers. Source: ABS.
47. The three ‘Free Trade Agreements’ completed last year do create some
real opportunities for Australian agricultural producers
No ‘Free Trade Agreement’ ever produces genuinely ‘free’ trade− and some of the ones Australia has signed
in recent years (eg with the US or Thailand) didn’t do much for Australian exporters. However the
agreements signed last year with Korea, Japan and China are genuinely ‘good’ agreements which open up
genuine opportunities for Australian exporters, including agricultural exporters.
The agreement with Korea
− immediately abolishes Korean tariffs on Australian sugar, wheat and wine
− provides duty-free access for seasonal horticultural products (such as potatoes)
− phases out tariffs on beef, sheep meat, pork, and dairy products over periods of between three and 13
years (in most cases)
The agreement with Japan
− provides for fairly swift reductions in tariffs on beef (though not complete elimination)
− institutes duty-free quotas for cheese & milk protein concentrates
− allows greater access for a range of horticultural products (especially seasonal ones)
The agreement with China
− provides for the phasing out of tariffs on beef, all dairy products, sheep meat, pork, fruit & vegetables
over 2-9 years
− and for a duty-free quota of 30Kt of wool growing to 44Kt 2024, in addition to Australia’s existing
access under a global 287Kt quota cases)
48. Where are we in the economic and stock market cycle?
We are in the
middle bear/late
business cycle
phase
49. Sector Rotation Model
Stage: Full Recession Early Recovery Full Recovery Early Recession
Consumer Expectations: Reviving Rising Declining Falling Sharply
Industrial Production: Bottoming Out Rising Flat Falling
Interest Rates: Falling Bottoming Out Rising Rapidly Peaking
Yield Curve: Normal Normal (Steep) Flattening Out Flat/Inverted
50. Persistent themes in the portfolio include:
Where to Invest in 2nd Quarter 2016
• Energy
• Transport
• Capital goods
• Mining
• Infrastructure
• Consumer Staples
• Financials and property stocks - becoming better value
51. Summary: Key risk drivers of forecast
Another global economic downturn
− the major ‘advanced’ economies have far less capacity to ward off another global recession than they did in 2008-09
− China arguably still has the capacity to respond as forcefully as it did in 2008-09 but is less likely to use it
− Australia has far less ‘policy ammunition’ than it did in 2008-09
A ‘hard landing’ in China
− China now takes almost one-third of Australia’s (merchandise) exports – a higher proportion than any single country
has done since the mid-1950s – and this figure understates Australia’s economic exposure to China
− as with a global downturn, Australia has far less ‘policy ammunition’ to respond to a Chinese ‘hard landing’ than before
A$ reversing course and rising sharply
− putting the RBA into an unpleasant dilemma as to whether or not to cut interest rates even further
A ‘housing bust’
− risk is widely exaggerated, but were it to occur it would have a bigger impact on economic activity (by prompting higher
levels of saving as borrowers sought to reduce debt and avoid default) than financial system stability.
Renewed erosion of business confidence
− most likely as a result of growing frustration with political outcomes and/or political system
− reflected in on-going weakness in business investment and (possibly) slower job creation
Failure to put budget on a credible path back to surplus
− not a problem requiring immediate drastic action, but rather steady progress over the next 4-8 years
− almost certainly can’t be achieved in politically acceptable ways solely through measures on one side of the budget
− failure will further hamper Australia’s ability to respond to any future economic downturn (however
caused) and lead to loss of AAA rating
