Economic growth slows with more stimulus on the way: CommSec's year in review

EXPERT OBSERVATION 

Australia’s record economic expansion has almost completed its 28th year. Interest rates have fallen to fresh record lows; wages are growing near 2.5%; underlying inflation is around 1.5%; the jobless rate is 5.2%.

Total returns on Australian shares (All Ordinaries Accumulation index) have lifted by 11.4% over 2018/19 (20-year average +9.5%) to a smidgen below record highs.

What does it all mean?

The 2018/19 financial year is almost complete and it is an opportune time to see how investments, financial markets and economies have performed over the past year.

Overall, the global economy has slowed over the past year, largely restrained by the US-China trade conflict. Central banks are now favouring rate cuts over rate hikes largely because inflation remains low.

The US economy generally remains in good shape. But Chinese authorities have been stimulating their economy in response to the slowdown caused by the trade dispute with the US.

The Australian economy is currently growing at a 1.8% annual pace – the slowest pace in 9.5 years. Just like other major economies, growth slowed over the year. Uncertainty over the Federal Election result also slowed activity ahead of the May 18 poll. Activity is expected to lift with election uncertainty resolved.

The Reserve Bank has re-assessed policy settings in response to stubbornly low inflation. The Reserve Bank now believes that unemployment can fall to 4.5% before igniting inflationary pressures.

As a result the Reserve Bank cut the cash rate by 25 basis points in June to 1.25% and has flagged another rate cut in coming months.

Inflation is expected to edge higher to around 2% in 2018/19 with unemployment 4.50-5.00%. But much will depend on the global trade environment.

Returns on shares have lifted by just over 11% in 2018/19 and growth of 7-11% is expected in 2018/19.

The Australian dollar should support the record economic expansion, largely holding in the late 60s/early 70-cent range against the greenback.

What does the data show?

• Interest rates

The cash rate was reduced from 1.50% to 1.25% in June. It was the first rate change since August 2016.

The market-determined 90-day bank bill rate has held between 1.21% and 2.10% over 2018/19 and is ending the year near record lows.

Yields on the long bond – 10-year government bonds – have held in a range of between 1.29% and 2.79% and yields are ending the year near record lows.

• Currencies

The Aussie dollar has fallen around 6% over 2018/19. The Aussie started the year around US74 cents and is ending the year near US69 cents.

We have calculated that the Aussie is ranked 103rd strongest against the US dollar of 120 currencies tracked.

The currencies of Thailand, Egypt, Uganda, Mexico, Philippines and Japan all have lifted around 3-7%.

The weakest currencies have been in the emerging economies of Venezuela, Argentina and Haiti. Only 24 currencies have lifted against the greenback over the year.

In the first six months of 2019, the Aussie dollar has fallen by around 2% against the US dollar, making it the 97th strongest of 120 currencies tracked.

The currencies of Russia, Egypt, Thailand, Central Africa and Canada have lifted around 3-10%.

The weakest currencies have been the emerging economies of Haiti, Argentina, Turkey, Pakistan and Ghana. Only 42 currencies lifted against the greenback over the year.

The Aussie has gradually trended lower for around two years. Over most of the period US policy interest rates were rising while the Aussie cash rate was left unchanged.

The Aussie fell from around US80 cents to US68 cents (if the January 2019 ‘flash crash’ to US67.43 cents is ignored).

• Commodities

Commodity prices eased over the second half of 2018 in line with slower global growth but recovered some lost ground in 2019.

The Commodity Research Bureau futures index has fallen by 11% over the year, but the CommSec daily index is up 3%.

The difference between the two indexes is basically iron ore, with its price up 81% over 2018/19 while gold and coking coal gained 12%.

Base metal prices fell 10-20%; oil is down 23% while spot natural gas has slid 58% and thermal coal fell 37%.

Sharemarket

The Australian sharemarket started 2018/19 with the All Ordinaries at 6,289.7 and the ASX200 at 6,194.6.

The All Ords currently stands at 6,734.3 points (up 7.1%) with the ASX200 is at 6,650.8 (up 7.4%). We estimate that Australia is 19th of 72 global bourses.

So far 35 bourses have recorded gains in 2018/19. The best performer has been hyperinflation-affected Zimbabwe but Argentina and Brazil have lifted more than 40%. The US Dow Jones has lifted by around 10%.

The worst performers have been West Africa, Nigeria, Kenya, Ghana, Lebanon and Pakistan and Egypt. The Irish sharemarket has fallen 12%.

In the first six months of 2019, the All Ordinaries has risen by 18%, ranking Australia 8th of 73 nations. Greece, Argentina, Russia and China have been amongst the top performers (up around 20-37%) while Lebanon, Sri Lanka and Oman are amongst countries recording the biggest declines.

• Investment returns

Total returns on Australian shares (All Ordinaries Accumulation index) have so far lifted by 11.4% over 2018/19, hitting record highs in recent days.

Returns on dwellings have declined by 3.6% to date in 2018/19 while returns on government bonds have lifted by 10.4%.

• Sectors & size groupings

Of the 22 identified industry sub-sectors, only eight have recorded declines in 2018/19.

Leading the gains have been Consumer durables & apparel and Telecom (both up by near 41%) followed by Commercial services (up 21%) with Software & services and Transportation (up 20%).

At the other end of the scale, Household & personal products has fallen by over 36%, followed by Autos & components (down 21%) and Energy and Capital goods (both down 8%).

Of the size categories, the ASX50 has outperformed (up over 9%) from the ASX100 (up 8%) and the Small Ordinaries and MidCap50 (up 1%).

What are the implications for investors?

Returns on shares are near record highs. In fact sharemarket returns have only fallen once in the past 10 years. So an investor that has employed a diversified strategy across asset classes would be well pleased with the performance over recent years.

The outlook for the sharemarket remains positive. The Federal Election is in the background for another three years. And the Reserve Bank has adopted a stimulatory monetary policy.

The Reserve Bank now believes that the economy can operate at a faster pace, thus generating greater job growth with the hope of driving the jobless rate to 4.5%.

The cash rate was cut by a quarter percent in June and a similar decline is expected in the next few months.

But the Reserve Bank doesn’t believe it can do it all alone – it is calling on greater fiscal stimulus.

Certainly Federal and State governments are being active in advancing new infrastructure projects. And with budgets broadly balanced or in modest surplus, there is scope for even more fiscal stimulus to be applied.

Over the coming year, infrastructure building and net exports will add to economic growth.

The Reserve Bank hopes that the stimulatory policy settings will lead to stronger household spending as well. Weaker home building will be the main factor weighing on growth.

Last year we noted: “Over the coming year CommSec expects the All Ordinaries index to be near 6,400-6,600 points in December 2018 and 6,600-6,800 points in June 2019”. The December forecast proved too ambitious but the June forecast looks to be safely achieved.

Over the coming year CommSec expects the All Ordinaries index to be near 6,800-7,000 points in December 2019 and 7,100-7,300 points in June 2020.

Housing markets across the nation are continuing to rebalance to reflect the increase in supply (new home construction).

Lower home prices and rate cuts will ensure that first home buyers remain active.

Investors are also expected to return although sharemarkets are expected to remain more attractive in the short run.

Over 2019/20, national home prices may post small gains between 0-4%. Since the Federal Election there have been signs of stabilisation of Sydney and Melbourne home prices.

The low inflation/low interest rate environment is entrenched, meaning that lower nominal investment returns are also here to stay. So investors will need to remain flexible and alert to the returns achieved across sharemarket sectors and across asset classes to ensure that their savings are keeping pace with the cost of living.

The ‘triple L’ theme (low unemployment, low inflation, low interest rates) will also dominate global markets over the coming year.

In fact the US Federal Reserve is already contemplating rate cuts despite delivering the last rate hike just over six months ago.

The Aussie dollar is expected to largely trade in the late 60s/early 70s against the US dollar over most of the coming year. But interest rate differentials between the US and Australia and the US-China trade discussions are the two factors that could move the Aussie out of the tight range.

At the time of writing, financial markets were waiting on the next instalment of US-China trade talks.

Successful completion of the talks should lead to a major upgrade in prospects for the global economy.

If agreement remains elusive, expect stimulatory monetary policies to remain in place in China as well as advanced global economies.

Craig James is Chief Economist at CommSec. 

Ryan Felsman is Senior Economist at CommSec.