Private Wealth View August 2017

“Trumponomics” refers to a set of economic policies proposed by United States (US) President Donald Trump post winning the US election in November 2016. The policies were seen by investors as an attempt to “reflate” the US economy into a new period of economic growth. The foundation of these policies were cuts to personal and corporate taxes and the introduction of fiscal stimulus programs related to infrastructure and defence.

Trump has proposed to downsize the tax bracket groups from seven to three and reduce the top marginal tax rate from 39% to 33%. Companies were also set to benefit from a reduction in the corporate tax rate from 35% to 15%. On fiscal (government) spending, Trump proposed to reduce non-defence discretionary spending by 1% a year, but increase spending on defence and infrastructure.

Financial markets have embraced the reform potential under the “reflation trade.” Equity markets have experienced a broad based rally since Trump’s election win in November 2016, with minor setbacks from geopolitical issues easily overcome. However, volatility has tended to increase when Trump has attempted (and failed) to pass the legislation to repeal Obamacare.

SP500 Performance since October 2016

“Obamacare” refers to law intended to improve the affordability of access to health insurance for US citizens implemented by the Obama administration. Trumps ability to repeal Obamacare is now seen as highly important, given it is symbolic of the administration’s ability to win the necessary support for his larger, more important economic policy changes.

The Trump administration we will be disappointed by its failed attempts to repeal Obamacare, with investors becoming increasingly sceptical about the overall ability of the Trump administration to implement change. Questions are now being asked whether the broader tax reform will occur anytime soon (or at all). Cuts to Obamacare would free up funding of about $834 billion from 2017 to 2026, and thus the government would use part of this money to finance the tax reforms. Trump has said the overhaul is not dead and he will try again after some additional lobbying with the key players.

The Trump administration has a broader vision to pass the tax reform in 2017. However, with the year well advanced and a second failed attempt on Obamacare, investors will want to see some tangible economic policy success prior to the end of the year to justify their initial enthusiasm.

With no significant changes having yet been implemented by the Republicans; will market remains well behaved in the second half of the year or will some of the uncertainty surrounding the Trump administration be reflected in global stock markets? For now Trump retains the confidence of investors, with his promises to the American people being as good as the actual reform.

Cash

For the month of April the Reserve Bank of Australia (RBA) left the cash rate on hold at 1.5%. The housing markets were a cause for caution and concern, with continued growth in the Melbourne and Sydney markets mismatching slower growth in other parts of the country. The Board also noted mixed figures in the labour market, where unemployment has slightly risen.

In the first couple of days of May the Board yet again decided to leave interest rates at 1.5%, unchanged for the past eight consecutive months. The Bank’s forecasts for the Australian economy have also not changed much, with economic growth expected to increase gradually over time. Labour market indicators remain mixed, unemployment data remains sound, whilst wage growth remains slow.

The Board met in June to yet again announce no changes to the cash rate. The Board reiterated concerns about low core inflation. Slow growth in real wages remained a concern – firstly putting a strain on household consumption, and secondly falling behind rising household debt levels. The housing market seemed to be at the forefront of decision making over the past three months, with continued rising prices remaining a concern.

The RBA once again made no change at the July meeting; however the minutes of the meeting released on the 18th of July included some interesting comments. Board members hinted at the potential to bring the cash rate to a “neutral rate” of 3.5% in the future. Investors assumed these comments were a signal that interest rates may be entering a new rising phase. The Board’s comments reflected the sentiments of most major international central banks, who now seem focused on “normalising” interest rates.

Fixed Income

April saw global yields fall as they continued the downward trend from the previous month; global bonds returned 0.74%, and Australian government bonds returned 0.79%. Australian 10- year Treasury yields fell 12 basis points to 2.58%; US counterparts returned 2.28% respectively.

Global yields fell further in May, continuing the trend from March; as investors increased their fixed income holdings. Global bonds returned 0.64%, the US 10- year Treasury yield fell to 2.2%, Australian government bonds returned 0.15%, and Australian 10- year Treasury yields fell to 2.39% – the lowest since November 2016.

Global yields pushed higher in the month of June and July, but have since settled back given Janet Yellen’s cautious comments about the pace of US interest rate rises. The market view remains that the US Federal Reserve will increases rates again in December this year. The combination of potentially slower interest rate rises in the US and faster rises in Australia put a rocket under the $A, which remains around the $0.79 level.

Australian Equities

The Australian equities market had a mixed month in April, returning 1.03%. The Materials, Energy, and Consumer Staples sectors weighed on performance, while gains came from the Industrials sector. After complications in its US business caused Brambles to make losses in the previous months, the company came back strong during April to gain +10.59%. This followed the announcement that it is on track to meet its 5% sales growth target; with the stock finishing the month at $10.34 per share.

The month of May saw Australian equities post a pullback of -2.75%. Losses were driven by the Financials sector (-7.16%) after having rallied on positive sentiment since November 2016 – ANZ (-11.24%) and Westpac (-9.26%) were hardest hit amongst the big four banks. The Materials sectors also posted an overall loss despite mixed results amongst companies. May’s market conditions generally benefitted income stocks, with Telstra gaining 4.27% alone.

The Australian market was relatively unexciting in June as the otherwise thrilling financial year came to an end, gaining a meagre 0.17%. The Healthcare and Financials sectors led the market gain. Despite leading throughout the year, Materials have been trending downwards since the end of January.

The Australian market has been having an interesting time through the month of July, with intraday volatility prevalent. APRA’s new regulation on bank capital supported the big four banks, with the new requirements already factored into the big banks’ capital plans. Healthcare also had a blow as CSL shares dropped following the Bioverativ’s law suit, however, the company’s impressive run continued with the shares bouncing back, lifting the whole healthcare sector.

International Equities

In the global environment, the MSCI World Index gained 3.57% in $AUD terms, boosted by Europe and emerging markets. US markets continued to rally during the month with the S&P 500 gaining 3.05% in AUD terms, despite a poor GDP growth figure of 0.7%. With US valuations starting to look a little on the high side, investors are holding out for the Trump administration’s proposed tax cuts to be made law. Tax cuts would be beneficial for company earnings and lend support to the current market valuation.

The EuroStoxx 600 Index rose 5.79%, as Emmanuel Macron looked to be the winner in the presidential election. The UK, Japan, and Chinese markets also made modest gains, and the MSCI Emerging Markets Index was up 4.24%, supported by gains from the Taiwanese and Indian markets.

For the month of May the MSCI World Index gained 2.68% in AUD terms, once again supported by Europe and emerging markets. The Eurostoxx 600 Index increased 5.38% and the MSCI Emerging Markets Index rose 3.43% with strong performance in the Chinese, Hong Kong, and Korean markets. In the US, the S&P 500 gained 1.87% in AUD terms.

The MSCI World Index fell 2.54% in AUD terms during June, dragged down by the European markets, and the MSCI Emerging Index also fell 1.97%. The US market showed signs of slowing down in June – the S&P 500 fell -2.34% in AUD terms, as the US central bank was unable to halt US dollar weakness late in the month.

In July the US Consumer Discretionary sector, particularly “bricks and mortar”, were being negatively impacted by Amazon’s purchase of Whole Foods. Tech stocks were also down slightly month to date, but remain in a continued upward trend. Overall, July may well end up negative for global equities as a result of a jump in the $AUD post the release of the RBA’s July minutes.

Alternatives Strategies – Hedge Funds

Hedge Fund strategies were largely flat over the quarter, with sector returning 0.03% across a broad range of strategies according to the Credit Suisse Hedge Fund Index.  Contributors to performance were exposure to Emerging Market equities and Long / Short Equity, while Managed Futures continued to detract from performance. Managed Futures, which benefit from trending prices across a wide range of markets, were unable to sustain early positive momentum in the quarter.

As discussed earlier in our special topic, Donald Trump will once again dominate headlines in the second half of the year. Investors will want to see some progress in “Trumpanomics” and some progress on repealing Obamacare.

All eyes and ears will also be on the Federal Reserve (Fed) for the next 3 – 6 months. Uncertainty remains as to whether the Board will raise rates for the third time this year from the current 1.25%, and secondly, whether it will begin reducing its balance sheet anytime soon.

Comments by Federal Open Market Committee (FOMC) Chair Janet Yellen indicated the recent rise in interest rates reflected the progress made by an economy which is expected to reached target employment and normal inflation levels over time. The Fed believes the recent dip in inflation is due to temporary factors and that the run of softer data should end soon.

Balance sheet reduction of approximately US$10bn a month continues to be on the table, but it is possible that the pace of balance sheet normalisation could slow if data does not meet expectations. The US dollar has continued to fall as result of this uncertainty and the recent failure by Trump to successfully repeal Obamacare.

The European Central Bank (ECB) has also joined the Fed in winding back some of its emergency policy from the Global Financial Crisis. ECB Chairman Mario Draghi has indicated that the ECB may start tapering some of its bond purchases. ECB bond buying has kept bond yields lower than would otherwise be the case for countries such Spain and Italy

The Fed and ECB’s policy has been supportive for financial markets since the Global Financial Crisis. So far the Fed has been able to get one foot out of the “exit” and the ECB is heading for the “exit”. It remains to be seen what overall impact the final exit will have on financial markets that have grown accustomed to Central Bank support.

We will continue to monitor the global situation closely and provide another update should any further material events occur.