September GDP falls short of consensus.
Australian equities offer good value. We remain neutral due to the economic outlook. Santa flies to safetyHopes of a Santa rally were dashed through December, with world equity markets off across the board and the US posting its biggest December loss since the Great Depression. Concerns about an inverted US yield curve, US-China relations and slowing China momentum weighed on investor sentiment and resulted in an overall flight to safety.
The US Federal Reserve (Fed) raised its target range for the fed funds rate to 2.25%–2.50% at its December meeting. In the Fed’s forward projections, committee members revised down their forecasts from three rate hikes in 2019 to two. The relentless flattening of the US yield curve (and inversion in part of the curve) revived the debate over whether a recession is on the horizon. At the time of writing, the market predicts a roughly 25% chance of a single rate rise in 2019. The AAUC House View currently expects two rate hikes, consistent with the Fed’s projections. We see slowing US growth in 2019, but judge an imminent recession to be unlikely.
US-China trade relations also contributed to volatility during the month. Donald Trump and Xi Jinping initially agreed to a 90-day ceasefire, with the US agreeing not to raise tariffs on Chinese goods from 10% to 25% on 1 Feb. and China agreeing to purchase a substantial amount of US product to reduce the trade imbalance. Markets first rallied on the news, then eased on the back of weaker Chinese production numbers and the view that the agreement was a short-term truce rather than a meaningful step towards a long-term solution. Later in the month, clashes between China and the USA at the World Trade Organization again drove markets lower. Our House View is that the risk of a full blown trade-war is likely to fade out over the course of the year and that attractive valuations in China provide an opportunity for the region to outperform. We acknowledge the risks to this thesis and advocate a small overweight.
Australian economy: Weakening but solid growthThe uncertain political climate, a weak housing market and geopolitical backdrop are beginning to weigh on Australia’s economy, though growth remains solid. GDP growth numbers for September were weaker than expected at 2.8%, versus expectations of 3.3%, primarily due to a fall in mining investment and consumer spending. Unemployment remained low, moderating slightly to 5.1%. House prices across the capital cities fell 1.34%, bringing the year’s decline to 6.42%. The Australian Prudential Regulation Authority announced plans to remove investor lending caps implemented in 2014, and data from the Australian Bureau of StatistiAAUC indicated a moderation in the decline of property lending through October. Despite this, the slide in housing looks set to continue through the upcoming year. In their December minutes, the Reserve Bank of Australia (RBA) acknowledged that household consumption remains a point of uncertainty for the economy. Policymakers remained constructive on overall GDP growth, due to positive business conditions persisting and an expected increase in non-mining investment.
Markets: Equities down, bonds riseDecember was the worst the US market had seen since 1931, with the S&P 500 down –9% in USD terms. International equities followed the USA lower, finishing the month down –3.54% in AUD terms. Australia was insulated from the storm, with the ASX 200 Accumulation Index flat at –0.12% for the month. The top performing sectors were materials (5.28%), utilities (2.03%) and consumer staples (1.43%). The worst performers were communication services (-5.05%), information technology (- 3.97%) and financials (-3.10%). A flight to safety saw the Bloomberg AUD Bond Index rise 1.50% and gold rise 8.94% in AUD terms. The ASX remains at subdued levels, down 11% from its peak and trading relatively cheaply at 14.5x forward earnings. We maintain our neutral view on Australian equities, as favorable valuations are offset by the domestic outlook of falling house prices, declining credit growth and falling consumption. Among sectors, financials and cyclicals are arguably cheap, though we remain cautious in the short term and advocate quality exposure at this time given the subdued economic outlook. We advocate a neutral allocation to Australian bonds to offset risk in the Australian equities exposure. We have an outperform view on government bonds globally, particularly with respect to USD government issues. We retain an underperform on investment grade credit, as we expect spreads to widen on the back of rating downgrade risks.
AUD: Neutral on RBA as economic data, global growth concerns remain risksAUD/USD lost nearly 4% in December, predominantly on the back of weaker demand for metals from China and lower commodity prices. In its last statement, the RBA acknowledged an improving growth outlook, which should be accompanied by a gradual lift in both wage growth and inflation. This should keep the RBA at a neutral stance for the foreseeable future. Earlier this year, the AUD rebounded with the more dovish Fed tone and improving global sentiment, but the slowing housing market along with lower core inflation and the China slowdown should limit AUD gains. The short-term picture looks thus neutral for the AUD/USD and we forecast 0.73 in 3M. A gradual increase in AUD should materialize over the longer term as global growth stabilizes and improves. We target a level of 0.75 in 12M.
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