Economic Snapshot – FY17 & Outlook for FY18

Economic Snapshot – FY17 & Outlook for FY18

In Summary

If ever investors wanted proof that uncertainty and political events in markets is a fuse to volatility but that economic fundamentals win, 2016/17 would be a good case study. Despite fears of an uncertain geo-political world results were strong in all equity markets – the area volatility excels.
Financial markets commenced 2016/17 in the wake of the Brexit result just a few days before and offered a frightening outlook. At the same time we had looming elections in Europe, where extremist candidates seemed to be making headway, as well as an unheralded US Presidential election with Clinton vs Trump. As things turned out, the European elections proved more benign than feared, the US election delivered one of the most startling results in decades and markets responded favourably through economic policy stimulus. Who would have imagined that?
After all the turmoil, global equity markets commenced a sustained rally that delivered strong double digit gains for the year as a whole. Other risk (equity) assets, such as high yield bonds, also performed very well. However, government bond markets had a poor year and bond-sensitive equities, such as AREIT’s [Australian Listed Property], underperformed with negative returns. In general these developments were driven by investors chasing the “reflation trade” – that is, a view that the world economy was finally entering a period of better growth with moderate inflation.

As 2017/18 starts, risk assets are looking less attractive than a year ago and markets are facing up to the end of the global interest rate easing cycle. From here on, interest rates go up rather than down, with implications for all asset classes, but most especially bonds and currencies. At the same time, the pace of global growth looks set to slow down, thereby providing less support for profits and cash flows. Given all this, equity markets sitting on high valuations look vulnerable to many analysts.

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Economic Snapshot – Annual 2016 & Beyond

Economic Snapshot – Annual 2016 & Beyond

This economic snapshot  covers 2016 with some perspective on how markets performed and why, with an outlook for the year ahead.

In summary

2016 was a dramatic year for the world’s financial markets. The year started with collapsing oil prices, fears of recession and deflation, equity markets falling sharply and investors favouring bonds and what might be termed “expensive defensives”.

By the end of the year, we had rising oil prices, renewed optimism about US growth and inflation, cyclical equities rallying, bonds selling off and defensives falling out of favour. In between we had on then off again OPEC deals, we had Brexit and we had the USA Trump victory which threw most fund managers. In summary despite all the noise and surprise political outcomes, we had a good year for diversified portfolios with positive returns recorded by a number of asset classes in 2016. This end result rewarded patient investors and masked the considerable within-year volatility.

2017 looks like being another year of volatility (the new normal) although somewhat surprisingly, forward looking expectations for asset classes have more upside room than at the beginning of 2016. This is an encouraging scenario built on economic rationale not geo political activities and market sentiment which, of course has a history of overturning expected outcomes in the short term. Snapshot comments cautiously on the outlook in the second half of this update given the interest of many readers for asset class outlooks.

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Economic Snapshot – July 2016

Economic Snapshot – July 2016

In Summary – a look at July 2016

The turbulence world financial markets unleashed by the surprise Brexit vote at the end of June quickly disappeared in July as it became apparent that any immediate negative impact would more than likelybe restricted to the UK. The issue of sorting out the actual exit has also been realised as a long term
programme meaning there’s no need to overreact.

What markets did do, is turn their attention back to the pace of economic growth and its implications for central bank policy. In general, the latest data show no signs of imminent recession in major key economies like the US and China. Equally there’s not enough US growth to clearly compel the Federal Reserve to lift interest rates in a hurry. Combined with expectations of further monetary stimulus in the UK, Europe and Japan, the markets were happy to resume buying both equities and government bonds.

After holding the cash rate steady in June, the Reserve Bank cut to a new record low of 1.5% on August 3rd. This came in the wake of the inflation report for the second quarter which, as expected, showedinflation remaining below the bottom of the Reserve Bank’s target range.

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Economic Snapshot – 2016 Review & 2017 Outlook

Economic Snapshot – 2016 Review & 2017 Outlook

In summary

In hindsight 2015/16 proved to be a volatile year of repeating mini crisis’. Despite the erratic political and economic news, we still enjoyed modest growth in most of the traditional main stream asset classes. This ended up coupling nicely with some surprisingly buoyant returns in bonds, small cap equities and listed property. Although this was an impossible task to foreshadow at the beginning of the year, diversification into what is traditionally the more volatile areas proved beneficial for investors.

Overall the year seemed to be full of new surprises, triggering bouts of volatility in equity markets and ever lower sovereign bond yields. It started with China’s devaluation in August 2015, shortly followed with OPEC’s decision to push the price of oil down to regain lost market share, and then extenuated with the Federal Reserve [Fed] in the USA generating on-off again messages about lifting interest rates. Finally, we had the surprising Brexit vote with the UK referendum deciding to withdraw from the European Union. Not surprisingly, this all undermined investors’ confidence in the global economy. However fears of imminent recession proved overdone as global growth slowed and resilience emerged in keeping with economic fundamentals. Some would say a victory for the economists.

In this very unusual environment investors continued to seek yield (Real Estate Investment Trusts and Infrastructure) while avoiding riskier growth assets (Emerging Markets). The US cash futures market ended the year pricing in no further move from the Fed for the better part of the next two years. Many commentators feel this is overly pessimistic and believe it’s likely that the Fed will have to take some cautious tightening steps in the coming year.

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Economic Snapshot for March – April 2016

Economic Snapshot for March – April 2016

Portfolios in March saw further improvement in global investor sentiment as fears of a recession faded due to better news on key economic data and some stability returning to the oil market. Equities recorded a positive return for the month, with emerging equity markets outperforming particularly well after their recent difficult months. The normal monthly graph looks significantly different to the 3 month equivalent for the first quarter of the year and as such we have included the latter for a better perspective. US equities for example have now achieved a moderate return of 1.18% for the quarter but this is due to a strong rebound of over 6% in March. This is a poignant reminder that when we take into account a minimum 5 year time horizon the graphs are merely snapshots of a point in time.
In the US, there were further signs of labour market strength and some welcome improvement in the pace of manufacturing activity. Core inflation also continued to edge higher. However, the Federal Reserve again reiterated its preference to move cautiously with further interest rate increases. This inevitably undermined the US$ and resulted in speculative trading and volatility.

There were also encouraging signs of improving economic conditions in China, with the manufacturing index rising to its best level since June 2014. This reflects the impact of further monetary and fiscal stimulus from the Chinese authorities in recent months.

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