Quarterly economic review - September

12 min read

Despite the current phase of geo-political turmoil, the polarisation of the support of the government in Washington, and at the Brexit negotiations and the constant threat of terrorist attacks, investors continued in the September quarter to concentrate on improving economic data – the best synchronisation of global economic growth since 2010 – and strengthening corporate earnings.

The synchronised global economic expansion is enabling a big shift in monetary policy around the world, with central banks looking to reduce their balance sheets following years of quantitate easing, and pull back on stimulus, with major implications for markets, inflation and the outlook for growth.

While China’s managed slowdown continues to keep investors cautious, the improving economic picture in the US and Europe is giving cause for optimism – particularly in the US markets, where the major indices pushed to record highs again this quarter.

Earnings growth is also the driving force in Japan, as the revival of the economy is mirrored on the stock market.

Developments in the global economy

The Australian economy grew by 0.8% in the June quarter, for annual economic growth of 1.8%. While that number came in below expectations of 1.9%, it completes 26 consecutive years of growth, with the last recession (two consecutive quarters of shrinking GDP) ending in June 1991.

The June quarter growth rate was a solid rebound from the 0.3% growth recorded in the first quarter of the 2017 calendar year. Domestic spending was a key contributor to growth, rising 1% over the quarter, powered by a 0.7% cent rise in household consumption, which accounted for half of the overall increase in GDP. Less impressive was the fact that population growth was also a strong contributor to the growth figure, with per capita GDP growth that was half the headline rate, at 0.4%.

However, the long-awaited economic shift away from the resources sector appears to be gaining momentum, with stronger-than-expected investment in the June quarter. Private-sector capital expenditure (capex) rose for the second straight quarter, and has now reversed a period of more than a year in decline: it rose by 0.8% over the quarter, seasonally adjusted, well above market forecasts for a 0.2% rise.

Rises in manufacturing and non-mining capex are helping to offset a fall in mining investment, and indicating that the non-mining sector can take over from mining as the main driver of growth. What was also a positive was that businesses are increasingly optimistic in terms of their spending plans: spending expectations for 2017/18 have surged 18% from the last quarter, to $AU102 billion.

Australia’s exports to China surged by 28.8% in the year to July, to a record high of US$96.2 billion ($123.3 billion): exports to the Middle Kingdom now account for just under one-third (32.7%) of Australia's total exports. Australia’s annual imports from China rose 1.6% to a 15-month high of US$61.6 billion in the year to July, representing 22.6% of the nation’s total imports. Australia’s exports to India hit a 5½-year high in the year to July, coming in at US$15.4 billion up 61.3% on the year.

Employment rose for the 11th straight month in August, up by 54,200 in August after rising by 29,200 in July (previously reported as a rise of 27,900 jobs). Full-time jobs rose by 40,100 while part-time jobs rose by 14,100. Economists’ forecasts had expected a 20,000 increase in jobs at best. In the most recent six-month period, the Australian economy has created 250,000 jobs, its best six-month performance in 17 years. Not surprising from the foregoing, the Reserve Bank of Australia (RBA) kept the official cash rate on hold at 1.5% over the quarter, although it has re-emphasised rising household debt as a major area of concern.

United States

US economic data remains strong, with June quarter GDP growth revised up to 3% annualised (from 2.6%), thanks to stronger business investment and consumer spending. This followed a 1.2% growth rate in the March quarter, and was the best quarterly growth figure since the first quarter of 2015.

But just as investors have had to get used to a new term in recent years, “frozenomics” – to explain the debilitating effects on US first-quarter economic figures of extremely cold weather – it seems we now have “hurricanomics,” with a particularly active hurricane season in the southern US having strong potential to depress economic data in the near term. Economists estimate that Hurricanes Harvey and Irma could cut as much as 0.6 percentage points from US GDP growth in the third quarter.

After buoyant US job figures in June and July - 220,000 jobs added in June, followed by 209,000 in July – August could not match that pace, with a disappointing 156,000 jobs created in August, and unemployment up slightly to 4.4%. On trend growth, however, US jobs growth remains upbeat, particularly in the private sector, which added 237,000 jobs in August.

The healthy US economic growth in the second quarter was driven by household spending and firmer investment, showing that the recovery is maintaining its momentum despite a lack of policy progress in Washington. On that front, it was “business as usual” on the political front over the quarter – with President Trump and the Republicans – following the collapse of their latest plan to repeal the Affordable Care Act – facing the fact that not even majorities in the both houses of Congress mean they can pass legislation, with rebellions from their own side.

The US Federal Reserve announced in September that it would formally begin normalising monetary policy, starting to reduce its US$4.5 trillion balance sheet. This “quantitative tightening” will begin at a slow pace: from October 2017, the Fed will stop replacing a small portion of the bonds that mature each month, aiming to bring its balance sheet down at the rate of US$10 billion a month, increasing to US$50 billion a month in two years. Simultaneously, Fed chair Janet Yellen turned “hawkish,” warning in a speech that it could be risky “moving too gradually” on US interest rates. This was taken as reaffirming that a rate hike was on the cards, most likely in December.

In the last month of the quarter, President Trump finally unveiled his new tax plan, calling it “a miracle for the middle class.” The centrepiece of the plan is a proposal aimed at lowering the corporate tax rate from 35% to 20%, while for individuals, collapsing the existing tax brackets from seven to three, with tax rates of 12%, 25% and 35%. But the plan faced immediate criticism, and no early certainty that it would pass in its initial form.

Geo-politics

On the geo-political front, the situation in North Asia deteriorated over the quarter, with the rogue state of North Korea launching a series of inter-continental ballistic missile (ICBM) tests – some over Japanese airspace, into the North Pacific – and raising real concerns that the range of such missiles now encompassed the continental USA. North Korean leader Kim jong-un threatened a launch to land near the US Pacific territory of Guam: President Trump responded by matching the North Korean leader’s apocalyptic rhetoric.

In September, the US prepared a resolution for the United Nations Security Council containing the most severe sanctions yet proposed on North Korea: led by China and Russia, the Security Council passed a watered-down resolution, showing the US that it would not get Security Council unanimity when it came to punishing Kim jong-un. However, China unilaterally stepped up its economic sanctions on North Korea. In any case, the Pyongyang regime simply responded with further missile flights, and the testing of hydrogen bomb, with the heavy implication that this device could theoretically be mounted on a missile capable of touching major US cities.

China’s intervention surprised Washington, which now thoroughly understands that Beijing will not allow war or regime change to topple the Kim jong-un regime. But President Xi Jinping’s action should be seen in the context of the 19th Communist Party Congress, to be held in late October: the once-every-five-years event is the major setpiece of Xi’s reign, at which he will most likely be re-anointed leader for at least another five years, and oversee a shaping of the Chinese leadership ranks to his complete liking. Beijing is trying to stabilise everything it can influence ahead of the Congress: Xi, expectedly would not want a rogue neighbouring state hogging the headlines during his big week.

China

China's official manufacturing purchasing managers’ index (PMI) continued to show expansion (a reading above 50), coming in at 51.7 in August and 52.4 in September, showing that factory activity remains strong. The private Caixin China manufacturing PMI – which covers smaller, private firms – notched a six-month high of 51.6 in August, beating analyst expectations, before showing a surprise fall to 50.6 in September.

Data showed in September that industrial output rose 6% annually in August, down from expectations of 6.6% – and July’s 6.4% – and registering the slowest pace this year. Retail sales grew 10.1% from a year earlier, compared to an expectation of 10.5% (and 10.4% in July), also the lowest figure in 2017. Fixed-asset investment in urban areas rose by 7.8% in the first eight months of the year, the slowest rate since 1999. In contrast, the September manufacturing PMI rose by 0.7 points to 52.4, showing accelerated expansion.

Japan

The Japanese economy grew at an annualised rate of 4% in the June quarter, easily exceeding the 2.5% rise forecast in a Reuters poll. That made six quarters in a row of growth, now the longest expansion in more than a decade. Rising domestic demand is the major contributor to growth, ameliorating weaker Japanese exports. If the economy grows in the current quarter, that would represent Japan’s best economic growth streak since 2001. In its monthly economic report for September, the government maintained its optimism on consumer spending and exports as domestic and external demand drive growth in the world’s third-largest economy.

The Cabinet Office used the expression that the economy was “on a moderate recovery” for the fourth straight month, raising optimism that the economy’s current expansion could become the second longest in the post-war period. The so-called “Izanagi” boom that lasted 57 months (between 1965 and 1970) was the second-longest in post-war Japan, but the current expansion phase, which began in December 2012, is considered likely to have entered its 58th month – the Cabinet Office determines the length of an economic boom retrospectively after examining relevant data.

The North Asian crisis flowed into Japan’s domestic politics, as Prime Minister Shinzo Abe called a snap election late in September, to be contested in October, asking for a mandate for the tougher diplomatic and defence policies he said were needed to deal with the escalating threat from North Korea (and for the continuation of his “Abenomics” economic policies.) Facing Abe is the unexpected figure of Yuriko Koike, Tokyo’s first female governor and founder of the brand-new “Party of Hope,” who has shaken up the Japanese political scene and made the election difficult to predict.

Europe

In Europe, the quarter’s political highlight was the German election in September, in which Chancellor Angela Merkel, after 12 years in power, won an historic fourth term, but her victory was marred by the hard-Right AfD party winning its first seats in parliament. The main opposition Social Democrats (SPD) saw their vote drop to a post-war record low, at 20.8%.

Elsewhere, the strained Brexit negotiations continued between the United Kingdom and the European Union (EU), with little progress evident; and calls for another UK vote. Seemingly out of nowhere, for everyone not Spanish, the Catalan independence referendum called by autonomous region’s government was catapulted to prominence late in the quarter, after Madrid declared it illegal – the actual vote, held on October 1, saw a huge majority of Catalans vote for independence, amid public-relations-disaster (for Madrid) scenes of security forces trying to stop people from voting.

Away from the headlines, however, the Eurozone economy grew by 0.6% in the June quarter, matching the rate seen in the previous quarter, but year-on-year growth accelerated from 1.9% to 2.2%, to its fastest pace since 2011. German GDP grew by 0.6% in the most recent quarter, Spain posted 0.9% growth, France reported 0.5% and the Netherlands provided the biggest surprise, surging by an unexpectedly strong 1.5%. In contrast, UK GDP growth underwhelmed, reported at 0.3% for the June quarter, and 1.7% year-on-year.

The unemployment rate in Germany fell to a record low in September (the data series began in January 1992) at 5.6%, as jobless claims declined more sharply than expected. Eurozone inflation in September was stable at 1.5%, missing forecasts of a 1.6% reading.

Developments in financial markets

Australian shares

The Australian market stagnated over the quarter, showing three losing months on the S&P/ASX 200 index – all by very small amounts – and dividends enabled it, on a total-return basis, to show a 0.7% gain for the quarter. The resources stocks provided much of the heavy lifting, with the S&P/ASX 200 Resources Accumulation index up 9.3% for the quarter, despite a 4.5% quarterly fall in the iron ore price. For the quarter the small-capitalisation stocks outpaced the market heavyweights, with the S&P/ASX Small Ordinaries Accumulation index posting a 4.4% gain, streeting the S&P/ASX 20 Accumulation index, on 0.4%.

The importance of total returns is demonstrated in the September quarter, when dividend payments go out: this year, there is expected to be about $15.5 billion in dividend payments mailed out to shareholders, with a further $6.2 billion going out in October. On top of the 20.2 billion paid in March and April, after half-year earnings results, the income returns are very important during periods of weak markets – even more so if markets are falling – and we’re seeing that importance this year.

International shares

In the US, three winning months in the quarter pushed the broad S&P 500 index 4.0% higher on a price basis, while the 30-stock Dow Jones Industrial Average gained 4.9% and the technology-heavy Nasdaq Composite Index ended 5.8% higher. The quarter-end saw record high closes for the S&P 500 and the Nasdaq Composite, while the Dow Jones closed just 7 points off its previous record close. It was the seventh straight winning quarter for both the Dow Jones and the S&P 500, while the Nasdaq recorded its fourth quarterly rise in a row. On a total-returns basis, the Dow Jones gained 5.6%, the S&P 500 added 4.5% and the Nasdaq Composite was up 6.1%.

In Europe, markets rose over the quarter: despite a firmer euro, the pan-European STOXX 600 on a total return basis gained 2.7% for the quarter, powered by a 3.9% rise in September. In Germany, the DAX gained 4.1%, the same total-return performance as the CAC 40 in Paris, while in London, the FT-100 index appreciated by 0.8%.

In Asia, the Nikkei index responded to the improving economic backdrop with three winning months, gaining 1.6% for the quarter – all of it gained in its only winning month, September, in which it rose by 3.6%. In South Korea, after a stellar June quarter, the KOSPI index managed two rises in the three months to September, enough to put it ahead by 0.1% for the quarter. Two out of three was also the rising proportion for the Hang Seng index in Hong Kong, which managed a 7% rise for the quarter – taking it to a 25.2% rise for 2017, which even outpaces the US trio. In China, the Shanghai Composite pushed higher in July and August, to the extent that a 0.3% drop in September barely dented a 4.9% rise for the quarter.

Fixed interest

Bond markets may have seen an inflection point late in the September quarter, as the announcement of Fed tightening and the similar bias of other global central banks made itself felt – although these developments had been well telegraphed to the market.

US 10-year Treasury yields added 3 basis points over the quarter, to 2.33%, but that masked a significant move in September, when the yield increased by more than 20 basis points, for the largest one-month rise since November 2016. The 30-years also showed a 3-basis-point rise, to 2.86% (up 13.5 basis points for September), while 2-year yields lifted from 1.38% to 1.48%. UK 10-year gilt yields surged from 1.26% to 1.37%, while German 10-year bund yields eased from 0.47% to 0.46%.

Credit spreads in the corporate sector, especially high yield, remained tight.  The Morningstar Corporate Bond Index (a proxy for the investment-grade bond market) rose 1.29%, supported by a slight decrease in long-term interest rates and modestly tightening credit spreads. In the high-yield market, the Bank of America Merrill Lynch High Yield Master Index rose 2.04%, with tightening credit spreads driving a significant amount of the rise.

Currencies

The five-year bull market in the US dollar looks to be coming to an end, with the euro up 12.1% and the yen up 3.5% against the greenback over the first nine months of the year. The euro picked up 3.4% against the US dollar in the quarter, but the buck managed a 0.1% rise against the yen. The ICE US. Dollar Index, which measures the greenback against a basket of six major rivals, lost 2.8% for the quarter. The British pound strengthened by 2.9% against the US dollar over the quarter, while the Australian currency managed a 1.9% rise, ending the quarter at 78.34 US cents.

Commodities

From an Australian point of view, the biggest story on the commodities front for the quarter continued to be the sheer volatility of the iron ore price: down 21.4% in September, iron ore shed 4.5% for the quarter, after losing 19.2% in the June quarter.

Crude oil regained ground in the quarter (West Texas Intermediate up 12.2%, Brent up 20.1%), with the energy and metals component leading the S&P GSCI Index (which tracks 24 commodities) to a 7.5% rise for the quarter, rebounding from a 6.5% loss in the first half of the year. The index’s industrial Metals sub-index, which reflects investment in aluminium, copper, zinc and nickel, gained 10.5% for the quarter, with zinc up about 14%, copper up more than 9% to a three-year high, and aluminium up about 10%.

The industrial metals saw tailwinds from Chinese GDP growth, inflation and the US dollar. In precious metals, Gold gained 3.1%, while palladium surged 12%, reaching a 16-year high during the quarter.

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Information current as at 30 September 2017. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material.