Wednesday, October 15, 2014

Quarterly Strategic Outlook - October 2014 Edition

This week we released the October edition of Quarterly Strategic Outlook incorporating the outlook for the global economy along with commentary on the key asset classes from our Head of Investment Strategy Keith Poore.

The September quarter was another positive one for our diversified fund investors. Bonds produced healthy returns with low global inflation, policy easing from the European Central Bank and ongoing Ukraine concerns keeping yields well bid. Share markets inched higher over the quarter assisted by solid earnings both here and offshore.  New Zealand shares outperformed global shares with no change of government removing the uncertainty risk premium. However, shares have entered a flatter and more volatile return profile recently. This is something we expect to persist given uncertainty over the path of US rate tightening and ongoing geopolitical tensions. The New Zealand dollar was sharply lower over the quarter on another large decline in dairy prices plus intervention in the currency market by the Reserve Bank of New Zealand. Improved global sentiment on the US dollar also contributed to the weaker New Zealand dollar over the quarter.

At the macro level, global growth continues to improve but that recovery is proving to be increasingly uneven.  Despite a weak start to the year, the US appears to have the greatest upward growth momentum of the major developed economies.  This is leading to divergence in growth prospects between the US and the Eurozone and Japan, which will soon progress to a divergence in monetary policy settings. The US Federal Reserve is likely to begin tightening monetary conditions from the middle of next year while the European Central Bank and the Bank of Japan are expected to continue easing for some time. We continue to expect global growth will be stronger in 2014 than 2013.   With growth in emerging markets expected to be unchanged from last year, global growth is forecast to come in at 3.3% this year.   We expect further recovery over the next two years with growth of 3.7% expected in 2015 and 3.9% in 2016.

The lack of inflation is the key theme in the investment landscape at the moment. Against this backdrop, we think rising interest rates in the US will be accompanied by higher growth, which ultimately will be positive for shares given valuations are not overextended. We expect rising US rates to modestly pull up global long term yields, lift the US dollar higher, and by implication push the New Zealand dollar lower. Consequently we remain underweight the New Zealand dollar, at benchmark for equities, underweight bonds and overweight cash across our diversified portfolios.

For the full report click here.

Thursday, September 18, 2014

NZ GDP beats forecasts

New Zealand June quarter GDP came in at +0.7% (qoq).  This was slightly stronger than our and market expectations of +0.6%.  Forecasts had moved down a notch following the release of weaker than expected manufacturing data recently.  The Reserve Bank was expecting 0.8%.  Year-on-year growth came in at 3.9% with annual average at 3.5%.

The sectoral breakdown was much as we expected.   Dairy sector activity was weak over the quarter as production “normalized” after prior strong growing conditions.  Forestry activity was also weak reflecting lower demand (and prices) for logs.  Non-food manufacturing was also weak.

On the upside, construction activity came in better than expected at +2.2% qoq.  That might seem low at face value but it followed a mammoth 12.5% increase in the previous quarter.  The sector is now 14.0% higher than year ago levels.  And the service sector (70% of the economy) posted quarterly growth of 1.4%, the strongest growth since 2006.

This result supports our view that there has been some loss of growth momentum recently, largely emanating from the external sector, but that growth would remain relatively strong overall.  We continue to expect annual average growth of 3.7% in calendar 2014 followed by 2.7% in 2015.

For more on the outlook for the New Zealand economy, have a read of our latest New Zealand Insights which you can find here.

No surprises from the Fed

There were no surprises from the Fed this morning.  Asset purchases were trimmed again and there were only minor changes to the economic assessment.  Forward guidance was unchanged.

The pace of monthly asset purchases was trimmed from $25 billion per month to $15 billion with an indication the Committee will end the program at the October meeting.  That fits with our expectations so no surprises there.

There was some market speculation the Committee’s forward guidance would change.  In the end they continued to signal there will be a “considerable time” before the Fed funds target rate is changed following the end of the asset purchase program.   In our view a change to a more hawkish forward guidance now seemed incongruous with continued easing.  But such a change is clearly getting closer: there are now two dissenters in the ranks (Plosser and Fisher).

There was no significant change to the economic assessment.  The critical point is the committee continues to believe there is “significant underutilization of labor resources.”  The inflation language was tweaked from “inflation moved closer to target” last time to “inflation has been running below target”.  That’s a nod to more recent inflation outcomes which has seen the annual rate of inflation pull back from the spike higher earlier in the year which the Committee had attributed to “noise”.

There were also no surprises in the economic and interest rate projections (the infamous “dots”).  The only change to the growth forecasts that stood out for me was the reduction in the mid-point GDP growth forecast for 2015 which was lowered 0.3% to 2.8%.  It stood out largely because it’s been a long time since any of our US growth projections have been more optimistic than the Feds – we expect 3.0% growth in 2015.

Interest rate projections were higher from 2015 onwards.  I’m ok with that.  It always seemed to me that once the tightening starts, rate hikes would be more aggressive than the Committee was indicating.  Importantly the median projection for the long run (neutral rate) was unchanged at 3.75%.

Monday, September 15, 2014

Forecast risk to China growth shifts to the downside

Only two months ago it looked like the risks to 2014 expected growth in China of 7.5% had shifted to the upside.  While I try not to read too much into monthly data, generally weak August activity data suggests the risks have now shifted to the downside.

Industrial production, fixed asset investment and retail sales all came in weaker than expect in August.  That followed release a few days ago of trade data showing that export growth had slipped from 14.5% in July to 9.4% in August, although at the time of the release of the July data we thought it looked too strong.

Negative monthly growth in industrial production and the decline in the annual rate of growth from 9.0% yoy in July to 6.9% in August is the most disconcerting element.  This appears to be related to the slowdown in the property market with annual rates of growth in the production of steel, cement, glass and household appliances such as washing machines all lower over the month.  In that respect a slowdown is perhaps not surprising.  However to put a monthly decline in IP into perspective there were only 3 such months during the GFC and only one other since, so this is an unusual occurrence.

Retail sales and fixed asset investment were also weaker than expected, although the annual growth of real retail sales ticked higher from 10.4% to 10.6%.  However sales of home appliances and furniture posted lower annual rates of growth over the moth which fits with the property slowdown story.  Sales of these items will likely remain a drag on growth in overall retail spending for the foreseeable future.

Manufacturing, infrastructure and property fixed asset investment all slowed over the month with the overall rate of year-to-date growth slowing from 17.0% for the period to July to 16.5% in the period to August.  Infrastructure had been holding up well on the back of stimulus and appears a likely candidate for more should activity continue to surprise to the downside.  The good news is the slide in property investment appears to be slowing.

After GDP growth surprised on the upside in the first half of the year, the risks to growth have again moved to the downside.  We had 7.4% penciled in for Q3.  While that looks optimistic now in light of the low IP result, export growth is running stronger than we thought it would at this point.

The Government appeared to take its foot off the stimulus pedal following the stronger data up to June.  We think we will see efforts to stabilize growth step up again.  Indeed the monetary authorities appear comfortable with the lower interbank rate over the last few weeks.  We also expect increased fiscal spending will be used should the government want to increase cyclical support for the economy along with further targeted reductions in the required reserve ratio.