Investment update - February 2019

February saw the positive start to 2019 continue, with equities markets recovering from their late-2018 correction amid increasingly accommodative central bank signalling, hopes of an amicable resolution to Sino-US trade tensions, and a Brexit extension as the 29 March deadline nears.

The Australian economy recorded mixed data, with fourth quarter GDP growth coming in at a disappointing 2.3% year-on-year; well below government and RBA forecasts of around 3.0% made earlier in 2018. The annual GDP print masked two key points – firstly, that annualised growth has fallen from 4% over the first half of 2018 to just 1% in the second half, and secondly, that on a per capita basis (that is, excluding the positive impact of population growth), the economy actually contracted two quarters in a row, putting the economy in a “per capita” recession.

Australian house prices continued to slide, taking the annual decline in both Sydney and Melbourne to 11.5%, while retail sales posted a disappointing increase of 0.1% in January after a 0.4% fall in December. With business and consumer sentiment weakening, the RBA is now firmly expected to cut rates, with market expectations of a 25 basis point cut by mid-2019, and a second cut by mid-2020.

More favourably, the nation’s trade surplus spiked to $4.5 billion in January – its second-largest in history - driven by a large increase in highly volatile gold exports. Foreign commodities demand continues to support the economy at a time when local household finances are becoming increasingly stretched.

US economic data continued to improve. GDP growth was an above-expected annual 2.6%, while unemployment fell back below 4.0% and jobless claims remained close to 50-year lows. Consumer data was also robust, with retail sales growing 0.2% in January (despite the government shutdown), and consumer sentiment gauges ticking back upwards.

Despite the positive news, US inflation remains more muted. The Federal Reserve’s preferred gauge, the PCE Index, increased by just 1.7% for 2019. With data presenting a mixed picture, the Fed remains neutral in outlook, indicating that it will be guided by data in the coming months before changing policy.

The Eurozone economy continued to stutter, with fourth quarter GDP growth revised downwards to an annual 1.1%. For its 2019 forecasts, the ECB cut core and headline inflation forecasts to 1.2%, and forecast GDP growth to 1.1%. In tandem with the downward revisions, the ECB announced a new policy measure to be implemented in September; “Targeted Longer Term Refinancing Operations”, or TLTROs. First issued in 2016 and 2017, TLTROs encourage banks to on-lend to the private sector at low rates.

Eurozone production beat expectations for January, especially in France, Spain and Italy, while composite PMI also improved from 5.5-year lows in December. However, manufacturing PMI measures reflected global trade concerns, with the regional measure falling below 50 for the first time since mid-2013, with Germany recording a six-year low of 47.6.

With the 29 March Brexit deadline looming, global attention now focuses on UK Parliament, which voted against the wishes of the Conservative coalition by agreeing to avoid a “No Deal” Brexit. Further votes and deliberations will now guide the approach, particularly regarding the Irish land border. An extension to the Brexit deadline is firming as likely. Political uncertainty has affected business and consumer spending, leading the Bank of England (BoE) to cut its growth forecast from 1.7% to 1.2%; the largest cut since the Brexit referendum. Inflation also weakened, falling below the BoE’s 2.0% target rate for the first time in two years. Unemployment, meanwhile, remained at a 40-year low.

Hopes remain of an amicable resolution to the trade dispute between the US and China, although negotiations are starting to become drawn out. The Chinese economy continues to falter otherwise, with exports falling 21% in February compared to the same month in 2018; the steepest decline in three years. The Chinese government also revised its 2019 GDP growth target downwards from 6.5% to a range of 6.0% to 6.5%, while manufacturing sentiment gauges were, understandably, increasingly negative.

With recovering US economic data and a dovish tilt from central banks, equities markets rallied strongly in February. Developed overseas equities returned 5.56% on an unhedged basis. Domestic equities, meanwhile, returned over 6% for the month. Volatility also declined, with the VIX Index falling to its lowest point since October last year. Fixed interest also benefitted, with corporate bonds in particular outperforming as credit spreads narrowed. Australian government bonds had a particularly strong month, with the weakening inflation outlook driving 10-year government bond yields from 2.24% at the start of February to a 2.5-year low of under 2.00% by mid-March.

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