Market Review
The weak start to the year reflected market concerns about a couple of dominant themes. Firstly, the US Federal Reserve late last year commenced the process of normalising short term interest rates by increasing the Fed Funds cash rate by 0.25% following an extended period of effectively zero “emergency level” cash rates. A few months earlier they had also discontinued their Quantitative Easing or “QE” program designed to increase money supply to the economy by the Federal Reserve buying government bonds and mortgage backed securities and holding them on their balance sheet. At the time of the US rate hike, the market took this move as a sign of growing confidence in the strength and durability of the US economy, and the Fed framed market expectations to expect up to four further 0.25% increases over the course of the calendar year. In January, the market shifted focus and became concerned that the Fed may have acted prematurely by tightening policy and that future rate hikes would have a negative impact on the fragile growth outlook and perhaps drive the global economy into recession. With the growth outlook in Europe and Japan much more sluggish than the US, their respective Central Banks continue to implement expansive monetary policy programs to stimulate growth and head off potential deflationary forces.
The potential for a continued economic slowdown in China also came into renewed focus during January. This was a persistent theme though the course of 2015 and contributed to a hugely volatile Chinese stock market and weakness in commodity prices. In the second half of the year however, the market seemed to become more comfortable that Chinese authorities had taken sufficient policy action to arrest the slowdown in the pace of growth which they forecast to come in at around 6.5%. During January however, persistent devaluation of the the Yuan by the People’s Bank of China (PBOC) coupled with weak trade data, telegraphed to the market that perhaps the Chinese economy was not travelling as well as the market had anticipated warranting the additional stimulus provided by currency devaluation. As always, the market remains very suspicious of “official” published data by the Chinese government which seems to consistently print in line with the expectations they set. Following on from the boom years in China during the 2000’s where growth rates regularly exceeded 10% fuelling the global commodities boom, the Chinese government has tried to engineer a gradual slowdown to more sustainable growth levels and to concurrently change the mix of growth from more investment led (building and infrastructure) to be more consumption focussed. We need to remember that China is not a Western style open free market economy, the Government and PBOC exert direct control over critical economic levers such as interest rates, capital flows, lending standards, the exchange rate and investment spending and that are left to market forces in most other economies.
The slowdown in China has a critical influence on the Australian economy due to trade linkages primarily through the bulk commodity exports of iron ore and coal being raw material inputs to steel production. The slowdown in Chinese growth has contributed to precipitous falls in commodity prices which has both negatively affected our trade account and terms of trade and seen the value of the Australian dollar fall from around parity to the US dollar as recently as May 2013, to its current level of around 71 US cents. Weaker commodity prices have also seen sharp falls in the share prices of major mining companies and stifled their level of investment spending which was once a significant driver of economic growth. The Reserve Bank of Australia (RBA) is looking for non-mining sectors of the economy such as housing, retail trade, business investment and tourism to compensate for the slowdown in mining investment. While the housing sector has been strong in Sydney and Melbourne in particular, the other sectors of the economy have been sluggish prompting the RBA to ease cash rates last year to 2%, still very high by global standards. With inflation well contained, it is likely that the RBA will need to further reduce cash rates during the course of 2016 to provide additional stimulus to the economy and offset the contractionary impact of increases in lending rates imposed by most banks late last year following tighter APRA capital requirements. In terms of government policy, the Turnbull government is reviewing tax policy and formulating plans to wind back the budget deficit in advance of the Federal Budget in May.
Somewhat curiously, the oil price has now become a barometer for the health of the global economy and the key driver of global equity markets. Markets reacted negatively to the decline in the oil price during January which fell to below $30 per barrel after trading over $100 per barrel as recently as mid-2014. It should be noted however that the falling oil price reflects over supply rather than a slackening of demand which continues to grow consistent with modest global economic growth. OPEC countries and Russia have maintained output levels and with the ending of trade sanctions against Iran, they have now begun to add to global supply. Far from being negative for the global economy, lower oil prices are likely to boost personal consumption as lower petrol prices increase disposable income for consumers. Paradoxically, history tells us that it is sharply higher oil prices that are negative for the global economy as was the case during the oil shock in 1973 which led to a severe sharemarket correction and a deep global recession.
