Economic Update – June 2018

Economic Update – June 2018

In our economic update for June economist we hear from David Bassanese, Chief Economist at BetaShares, a leading ETF manager, and previously an economic columnist for The Australian Financial Review for over a decade. Prior to the AFR, David spent several years in the financial markets as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank.

Kaplan Ontrack asked Bassanese for his views on the Federal Budget, the future of Australia’s major banks and why he still likes the US tech giants.

Question 1

The 2018 Federal Budget has been described as a typical pre-election Budget with plenty of winners — although probably not winning all that much — and not many losers. What did you make of it?

Answer

I thought it was a pretty fair compromise in terms of how to spend the Budget windfall they got. The big news is that revenue has turned out better than expected over the last year or so: better commodity prices, very strong employment growth. And they’ve basically spent half that windfall through tax cuts and the other half to bring the Budget into surplus a little bit earlier. So, a reasonable compromise.

For a pre-election Budget, they could have spent a lot more, or for those that wanted them to be super responsible, they could have banked a lot more. I think the compromise is reasonable and actually giving some support to consumer spending at the moment, which is the weak part of the economy, through tax cuts is probably not a bad thing to do either.

Question 2

Most forecasts for the Australian economy in 2018 are cautiously optimistic, driven by improving global conditions but tempered by that uncertainty around household consumption — which presently looks very different to business confidence. How do you see these trends playing out this year?

Answer

That is the big question. If you look at the economy, business sentiment is quite high. Business investment is recovering, so we’ve got non-mining investment picking up. We’ve got mining investment bottoming out. Consumer spending has been okay but not fantastic.

Now, the challenge for consumer spending in the coming year will be that employment growth looks like it’s slowing. So, that contribution to income is going to die down, but the official forecast is still for quite solid growth in consumer spending, in fact, growth near 2.75 or 3%; and I see that is the risk that consumer spending may actually be a bit softer than that. So the forecasts certainly from both the Reserve Bank and Treasury at the moment are 3 to 3.25%% growth. Probably, the risk is on the downside to those forecasts.

Question 3

We’ve seen that Australia is probably slightly behind the curve — particularly behind the US — in terms of the recovery, and major global factors are a big influence. What do you see some of those major international factors being and which ones will you be watching particularly closely over the remainder of this year?

Answer

I think the single greatest factor to watch out for is the US labour market and particularly any pick-up in wages growth. We’ve got the US now with unemployment rate of 3.9%, close to most estimates of full employment. The risk is that if wages growth does start to accelerate, the inflation story will become not as favourable and the Fed could get more aggressive in raising interest rates. That will bring on the downturn in markets.

But if wages growth remains moderate, the US economy can continue growing quite well, and interest rates in the US will not rise aggressively. That’s quite bullish. So that is I think a key swing variable for the markets and global economy over the coming year.

Other issues are, in China, for example, the extent to which they can cut back their overcapacity in steel production. They’re talking about scaling back loss-making steel producers, which could have a negative impact on iron ore prices. That’s another issue to watch. Obviously, Donald Trump and the political fights that he’s having around the world is another thing to watch.

At the moment, the markets are basically saying his bark is worse than his bite. He makes a lot of threats, but doesn’t necessarily go through with a lot of those. He has recently now announced that he will pull out of the Iran deal, so that is some sign of action. But, again, that’s going to be a lingering source of concern and uncertainty for markets.

Question 4

The US tech giants have performed well during the current US earnings reporting season despite a number of headwinds this year. Are you still holding the likes of Apple, Amazon, Microsoft, Facebook and Google and what are their key challenges ahead?

Answer

I still like the tech giants. Firstly, from an overall market point of view, the NASDAQ 100 index, which they’re all part of, is still reasonable value. The P/E ratio for that market is around about 18 times earnings. It’s still below the long-run average of 24. In fact, the pullback in the markets at a time when earnings growth has still been rising has made those valuations even more reasonable.

If you look at the actual earnings results, all those companies, their core businesses are still doing very, very well. Users of Facebook, advertisers, users of Google haven’t really fled despite the concerns over data. And they’re also diversifying into new areas, like streaming services, cloud computing. Amazon, Google and Microsoft all have very strong cloud computing businesses now as well. So the outlook I think still looks quite reasonable.

The big risk for those companies are regulation and the extent to which they do clamp down on the use of private data. But, at the end of the day, the key advertising business of micro-targeting ads at specific groups is still going to be around, maybe not to the extent which it is at the moment, but I still think whatever will remain post-regulations, they’ll still be playing a very strong role in that market.

Question 5

The major Australian banks and AMP have had a tough time of it recently with the Royal Commission’s inquiry already claiming a few scalps. Additionally, growth prospects appear to be subdued with a cooling housing market particularly in Melbourne and Sydney and tighter lending standards being applied. How do you see the next 12 months playing out there?

Answer

Still challenging for the banks. Their growth opportunities are very challenging. They face regulatory risk. We’re not sure what will come out of the Royal Commission in terms of their clampdown in their activities, the extent to which they use brokers, their financial planning businesses. So, there’s a lot of regulatory risks that they face. From a macro point of view, the credit cycle is slowing down. The housing sector is slowing down, led by the Sydney property market. So that’s not going to be a source of growth as well.

I think they’re still going to have a very strong position remaining in the markets. They still generate good profitability from their core business of home lending. So I see them increasingly as more like utility companies in that they don’t have great growth options, but they do still have a relatively reliable income stream that generates good dividends. And that’s increasingly the way I think investors need to look at banks as modern-day utilities rather than chasing the strong share price appreciation they’ve enjoyed during the leveraging boom of the past decade or so.

Question 6

Does that mean diversifying from their wealth management arms and do you have any confidence that whoever comes in and buys the wealth management arms or the financial advisory businesses will be any better?

Answer

Well, that is one of the challenges. If you look at the Royal Commission, even the independent financial advisers out there, there have been some challenges in the way they do their operations as well. So there’s a new set of regulations [which will] eventually to come out of this, which will be good for consumers — better transparency over fees, better transparency around vertical integration.

I think both banks and the financial planning industry overall ideally will get new regulations which will I guess provide more confidence in that sector and, at the end of the day, what we do want is investors to feel confident going with financial advisers and getting good financial advice. New regulations can help. In that regard, I think it would be a good thing.

Question 7

Finally, what are some of the key trends you expect to see in the Australian ETF market this year?

Answer

Continued good growth in the EFT industry. Its share of the market overall within funds management is still quite small, but it’s growing. Actively managed funds are a major new growth area. I think a lot of managed funds active managers are seeing ETFs as the better mousetrap.

They actually offer ease of access. Investors can invest directly in your funds on the ASX. Unlike say listed investment companies, the beauty of an ETF is that they track their underlying net asset value relatively closely. So if you’re a good active manager with a good track record — a lot of them now are creating actively managed exchange traded funds if you like and coming to the market with those products. We have some. We’ve done a partnership with Legg Mason most recently.

Magellan have come to market with their own set of funds. I think that will be a new trend, a lot of the good active managers with good reputations coming to market. That will also show that ETFs aren’t just about passive investing. That plays an important role, but good active managers can use that product structure as well.

 

Sacha Loutkovsky
sacha.l@orionfg.com.au
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