Markets are hard to read

When the federal Budget was handed down last month, the government’s mantra was gloom and doom. Tough fiscal times demanded tough policies, and, as prime minister Tony Abbott and treasurer Joe Hockey told us, repeatedly, that’s what their first Budget delivered: tough love.

Well, Australians got that message, loud and clear; times were bad. Just two weeks after the Budget was announced, consumer confidence, as measured by the ANZ-Roy Morgan's weekly survey, plunged to its lowest level since 2009. Although it has recovered from that low point, no one is suggesting that Australians are brimming with confidence about the economy. That tell-tale sign of consumer confidence, rising property prices, has slipped into neutral, or has even gone backwards, in sharp contrast to last year’s buoyant markets, especially Sydney.

Yet, within days of that ANZ-Roy Morgan figure, the Australian Bureau of Statistics released the national accounts for the first three months to 31 March 2014. Surprise, surprise: there was life in the economy after all, with growth in this period of 1.1 per cent bringing Australia’s annual growth rate to 3.5 per cent for the 12 months to March. It seems our miners are still finding export markets, and the construction industry, aided by low interest rates, is finding new life.

The figure, which put Australia back in the league of the fastest-growing economies in the world, surprised economists and businesses alike. But not as much as it surprised the federal government. After all, it had only projected annual growth rate of 2.75 per cent this financial year and only 2.5 per cent in 2014/2015. That figure could prove conservative, especially as the most populous state, NSW – an economic laggard for some years – contributed more than half of the quarter’s increase. For the year to March, its economy grew by 4.7 per cent, by far the largest increase of the states.

Remember, too, the rebalance away from mining investment may not be too painful. Although an iron ore price below $100 a tonne is a salient reminder that the industry’s halcyon times are behind it, export growth is likely to continue over the next 12 months. This is thanks to a decade of mining investment that is still continuing to pay off, especially when natural gas exports, which come online later this year, are added to the equation. Consumer spending is harder to predict. No doubt the Budget sent a chill down the spine of many consumers, even though the main fiscal impact won’t be felt until 2016/2017. But it’s what people think that influences spending. And this government has driven home a message of austerity, suggesting people will be reluctant to get out their wallets and purses.

There are other variables, too. To date it’s been a mild winter on the east coast, something clothing retailers and energy producers won’t be enjoying. But the dollars being saved on winter fashions are possibly being spent on cafes and restaurants as people take advantage of the balmy weather. At this stage it’s hard to measure and we need to wait for the official numbers.

As mentioned, housing prices appear to have stalled. If this becomes a trend it will further depress consumer confidence. But it could be the case that consumers are taking a deep breath and seeing how the economy performs before returning to the market in spring. If this is the case, the latest set of national account numbers will send a message that their job is that much safer. Certainly there is nothing in the recent data that suggests interest rates are about to rise, although if the economy keeps ticking over at three per cent plus the direction is more likely to be north than south – possibly at the end of the year or early next year. So how to distil these domestic numbers? Although the underlying economy is probably performing better than expected, there’s little argument the Budget has depressed consumer sentiment. So it’s little wonder that investors are confused, and this is reflected in the share market. The benchmark S&P/ASX 200 only gained 0.1 per cent in May – we should probably be grateful it didn’t move into negative territory – and has only gained 1.1 per cent since 28 February. For the past 12 months, however, it’s still in double digit territory with a gain of 11.5 per cent. That investors are sitting on the sidelines is not only reflected in the price of equities; liquidity, too, has fallen.

Investors can draw little guidance from the mixed economic messages coming from overseas. On the upside, the US share market enjoyed another strong month in May with the S&P500 up 2.1 per cent. For the past three months it’s ahead 3.4 per cent and for the year a staggering 18 per cent. The market continues to be fuelled by positive economic data (especially falling unemployment), suggesting the slow-down in the first quarter was weather-related. The unemployment rate is now tracking just over 6 per cent, and average hourly earnings are increasing. To date, this falling unemployment rate has not triggered any significant pick-up in wages growth, but could be one of the big economic stories in the second half.

If the world’s biggest economy is a better “good news” story, the same cannot be said for Europe where the May Purchasing Managers Index numbers suggest the euro-zone recovery remains lacklustre. The small fall in the composite PMI in May, to 53.9 from 54 in April, left the index consistent with quarterly GDP growth of about 0.4 per cent which was slightly stronger than the return from the first quarter of 0.2 per cent. Europe continues to struggle.

What’s not making it any easier are the ongoing political tensions in the Ukraine, although the fact that pro-European Union Conservatives and Social Democrats won about two-thirds of the vote for the recent EU parliament elections, and Euro-sceptics only won 18 per cent of the vote, gave a spluttering Europe a shot of confidence. But six years after the GFC, growth remains patchy – at best – and fiscal problems still beset most of the Union’s members.

China had a better-than-expected month with the HSBC Flash China Manufacturing PMI up to 49.7 (from 48.1 in April) suggesting that downward pressure on the manufacturing sector is easing. It seems that stronger external demand, along with a rebound in infrastructure investment, is helping moderate the pace of economic slowdown. But China growth is slowing, and that’s hardly a positive signal for Australian investors.

In Japan, the headline index for the inaugural flash manufacturing PMI rebounded from 49.4 to 49.9. That favourable number helped the Nikkei bounce 2.3 per cent in May and it now looks like breaking its downward trend. India, too, appears to have settled down post its recent election with its share market one of the better performing emerging markets in May. Globally, both market volatility and liquidity have fallen – markedly. It’s not just equities; bonds and foreign exchange are similarly afflicted. The stronger equity markets are going hand in glove with a bond market rally. The bond market may be factoring in a pessimistic outlook for inflation and economic growth; equities are taking a more optimistic view on macro outcomes.

At the same time there is a lot of cash sitting on the sidelines waiting for a home, based on surveys of global fund manager portfolios. Considering these investors are hardly enjoying good returns given cash rate yields, where they decide to invest, and, perhaps just as importantly, what will tip them back into the markets, will be fascinating to watch. My prediction is a continued resurgent US economy – it could be just the signal we are all waiting for.

About George Lucas

George Lucas is managing director of Instreet Investment Limited. He has over 24 years' experience in the investment banking and funds management industries specialising in developing, managing and structuring financial products.

He was previously a director of two listed investment trusts, chief investment officer at Mariner Financial, and a senior equities derivatives trader with Citibank and First Chicago in London.