Economic Update – January 2020
by Infocus Author
Optimism for share markets in 2020.
– Equity markets offer good growth and yield opportunities
– US-China tariff deal could be big news
– Clarity over Brexit gives more growth prospects.
We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.
The Big Picture
Before we launch into our set of predictions for 2020 and beyond, it is worth reflecting on the decade that just ended.
The ASX 200 started the decade at 4,871 and it ended at 6,684 – or 37.2% higher. That amounts to an annual growth rate of 3.2%. Not great but it beat cash. When dividends are included, the growth turns out to be 113.2% or 7.9% pa. Of course, many Australian residents also received franking credits possibly adding over 1% pa to that growth.
Along the way, investors had to duck for cover as many commentators predicted several ‘hard landings’ for China, recessions in the US and the world and numerous other false signals.
The S&P 500 did even better than the ASX 200. It started the decade at 1,115 and ended it at 3,231 for a growth of 189.7% or 11.2% pa. With dividends, that growth rate rises to 13.6% pa. Of course, Australian investors may have also benefited from the 22% fall in our currency over the decade depending on how their overseas investments were managed.
We are still positive for equities going into 2020 but there are some false signals that need to be considered. Capital gains in both indexes were very strong in 2019 [ASX 200, +18.4%; S&P 500; +28.9%] but here the context is important. The US Federal Reserve (“Fed”) frightened markets in early October 2018 sending markets sharply lower. It so happens that the reaction was unnecessary as the Fed reversed its comments over the following months. The markets bottomed around the end of 2018 so the 2019 gains included ‘fundamental’ growth plus the correction of the earlier over-reaction.
Our estimates put the actual fundamental growth in 2019 at only a little over average rather than stellar. Our forecasts for both markets in 2020 are again just above average (before dividends). With bond yields and cash rates expected to continue at around the current low levels, equities are likely to be about the only way to earn both yield and growth in 2020.
Every year produces market surprises which are unpredictable. However, we can suggest some other possible sources of known possible surprises and whether these are more likely to be positive or negative.
The phase 1 deal in the China-US tariff war is likely to be signed very soon and this would be a strong positive for US and global growth if both sides stick to it. With the presidential election in November, Trump is incentivised to keep the deal on track.
The Fed has stated that it will keep rates on hold in 2020 while markets are still pricing in a possible single cut. Certainty in understanding and believing the Fed is always a positive. Our scenario for 2020 is continued low bond yields and cash rates.
The recent landslide victory for Boris Johnson’s conservative party in the UK will almost certainly end the three and a half years of Brexit woes with a clear break from the EU in January. There is plenty of positivity about possible new trade deals with the US, Australia and a temporary deal with Europe. There is no talk of major moves of international banks from London to Europe as were once predicted.
Since Johnson is likely to help the transition with fiscal stimulus, the UK and Europe could be in much better shape in 2020 than the last few years.
China economic data have turned the corner and we expect a solid post-tariff-war growth from China.
Australia remains in sluggish economic times. However, growth and jobs are solid – just not strong. The Reserve Bank is likely to cut its rate again – at least once in 2020.
We will tease out these predictions – and others – in the sections that follow. Unlike in past years, none of the main economic known situations seem likely to be negative for markets – but, of course – there is always the completely unexpected!
Big banks suffered later in 2019 over the Westpac money laundering scam and other banking crises. Financials lost 6.0% in the second half of 2019 (H2) while the broader index rose +1.0%. Telcos losses were even worse than Financials with a loss of 8.2% in H2.
The banks are currently cheap but uncertainty over possible future revelations makes heavy investment in them bold to say the least.
All sectors had a bad last two days of 2019 but that is more likely attributable to profit taking and accounting creativity at year end. There was no bad news to speak of and volumes were low. Materials had a strong December rising +1.5%. The ASX 200 lost 2.4% in December.
The S&P 500 is currently overpriced by our measurements. Making our fundamental projected growth (+11%) more like an actual 7% or so when current mispricing is factored in. A year ago, we had mispricing at about 15% which helped fuel the ‘stellar’ headline returns of 2019.
The Health sector of the S&P 500 had a spectacular year in 2019. If the Democrats are elected, that could put downwards pressure on Health stocks. Either way the main gains seem to be behind us.
While the ASX 200 went backwards in December, other major indexes did very well: S&P 500 (+2.9%), FTSE (+2.7%), World (+2.7%) and Emerging (+5.9%).
Bonds and Interest Rates
The Fed was on hold in December and its so-called ‘dot plots’ that represent members’ forecasts showed the Fed to be on hold for 2020 with one increase in 2021 and one more in 2022.
The CME Fedwatch tool that prices possible Fed rate changes off futures prices puts the chances of a ‘no change’ outcome in 2020 at above 50% but this figure moves from day to day. There is little or no support for a hike and one (or possibly two) cuts is expected by the market.
The RBA was on hold in December and does not meet in January. Many, including us, think there is at least one cut left in the RBA. Previous talk of QE by the Bank has subsided but they might do something creative in 2020.
The prices of iron ore, copper and oil all had a very strong month in December. Our dollar appreciated +3.4% against the US dollar taking it back above 70 US cents for the first time in a while.
The Saudis appear to be working hard to get a stable equilibrium price for oil. It has been suggested that the Saudis need the price of oil above about $80 / barrel to balance their budget but Russia can make a profit at $50. Interesting times!
Our Q3 GDP growth figure came in at the low end of expectations in early December – just after the RBA kept rates on hold.
The quarter on quarter growth was +0.4% which, over the year, turned out to be +1.7%. Since that annual figure was the same as population growth – both natural and through immigration – the per capita growth was 0.0%. Hence, we are going nowhere towards building a stronger economy but, at least, we’re not going backwards!