July Economic Update – Halfway There!

July Economic Update – Halfway There!

As we move into the second half of 2018 we thought it would be a good time to take a quick look at how markets have performed in the first half of the year and look at the expectations for the second half of the year. And who better to review the economy than our very own Chris Kelly!

The first half of the year has seen a bumpy ride for the world markets but the ASX 200 index has risen and if you including dividends of around 2.3%, the market is up around 4.5% in the first half of the year. The US market index, the S& P 500 is also up 2.7% but the MSCI Global index ex-US is down 2.8%.

The mood of most economists could be described as “cautiously optimistic” as the world economy continues to recover in most regions, driven by the re-emergence of the US consumer and entrepreneur.

The US equity market has already successfully dealt with 2 rises in the US rates in the current year (plus the 0.25% rate rise in December). 

There is a lot of good news already factored into the market prices and the growth in the US needs to be maintained, a reality Donald Trump seems well aware of through his offer of tax cuts.

However, some threats to the global and local market have emerged in the first half of the year warrant consideration.  Note when considering these challenges, at this time last year the US had 3 carrier task forces parked off the Korean peninsula and since then relations in the region have greatly improved.

The Potential China and US Trade War

Donald Trump and US congress has taken a stand in an attempt to redress a current imbalance of trade between the US and China. Whilst it seems improbable that China will open its market to more US manufactured goods, the initial war of words has certainly sent a scare through the Chinese equity market, measured by the Shanghai Composite, down approximately 8 % in June.

The reason for the US action is more than just an attempt to improve their ability to sell manufactured goods into Asia – there is a very real fear that as China catches up economically it is also becoming an equal militarily, an area where the US previously held a distinct advantage. One of the issues the move may address is the Chinese use its controls on foreign investment to obtain access to technology.  This access to US technology has been made possible because whilst  Chinese companies are free to set up business in the USA without intervention, US businesses need to partner with existing Chinese businesses and disclose a great deal of internal information, in order to operate in China.

If the two sides fail to reach an agreement, there is potential for a trade war to reduce global production efficiencies and impact not just on the economies of the protagonists but to impact on a number of other regions. As China is Australia’s biggest trading partner, there could be some serious implications for our economy.

Australian Property Deflation

After very strong gains in property prices along the Australian east coast, especially in the capital cities of each state, the property market has begun to cool. A number of measures have taken effect and prices in Sydney, Melbourne and Brisbane have begun to fall. The RBA and regulators will need to closely watch the prices to ensure a soft rather than a hard landing.

Recent news articles have been highlighting a number of aspects that are affecting the clearance auction clearance rates and the residential property market in general.

The following behaviours and regulations in combination are creating a drag on the property market:   

  • Overseas buyer and in particular Chinese interest has declined in recent times, this is partially due to three aspects, the tightening of restrictions on residents taking money out of China, other property markets becoming more attractive for Chinese buyers and also the imposition of additional costs being imposed on Australian property purchased by overseas residents;
  • A large amount of residential apartment construction is completing in the next 6 to 12 months and so the supply of properties for sale will increase;
  • A number of borrowers will find their interest only loans are maturing and need to be refinanced. However, there are a number of lending controls now enforced on the banks which mean that these loans will need to be renewed as principal and interest arrangements. Moving from interest only to principal and interest can have a dramatic impact on repayments required

 

Further Tensions in the European Union

As the Brexit process lurches from one issue to the next, other European Union countries are beginning to groan under the strain of operating as a single economy. In the last month, Italy has certainly become the focal point of issues stemming from the fragility of a unified Europe. However, with a resurgent Russian military flexing its power on the doorstep, most of Europe is working as closely as possible to prevent a further dissolution of the Union.

When we take a closer look at Italy, we can see the following challenges emerging:

  • The growing difficulties in continuing to accept Syrian and African refugee inflows under policies in effect in the European Union;
  • A growing dissention in the local population with the influx of refugees who many see as creating fresh economic problems and taking employment positions which would normally otherwise be allocated to long-term residents;
  • The high rates of unemployment especially for the youth and the difficulties competing globally;
  • Ongoing fragility of the Italian banking system and ongoing issues with the single Euro currency. The single currency reduces the competitive advantage for weaker economies in the European Union which in the past would deflate their currencies to make goods and services more competitive.

 

As always, this article should be considered as general advice only. The next six months are likely to turn up further business opportunities and challenges. The global economies and markets will continue to be driven by emotions and fundamentals and long term investors will need to have a plan in place to navigate the future successfully!

Chris Kelly
chris@orionfg.com.au
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