vaneck viewpoint · 1985 1990 1995 2000 2005 2010 2015 2019 4 qtr pp cont to gdp 12m% total housing...

VanEck ViewPoint™

Global economic perspectives

April 2019

2 VanEck ViewPoint™

Market summaryAfter a plunge in equity markets through the December quarter, culminating in the Christmas Eve “Mnuchin Massacre”, the March quarter saw “The Return of Goldilocks” – a strong rally in global asset markets. This rally was apparently triggered by a clear turn in Fed rhetoric and has rewarded those investors who took the December quarter correction as an opportunity.

The “risk-on” sentiment was most pronounced in Emerging Markets with China A-shares returning a whopping 29.6%. At a sector level, both here in Australia and overseas, Information Technology companies have roared ahead returning 22.7% and 17.9% respectively year-to-date.

Europe’s sluggish growth is a cause of concern for the Fed whose recent comments about no more rate hikes and whose downgrade in economic forecasts has seen the US 10-year yield at levels not seen since January 2016. The current state of Brexit is more a case of kicking the can down the road, with perpetual speculation as to what will transpire and a British public tiring of the political squabbling. On the commodity front, gold bullion has been relatively stable, remaining around US$1,300 per ounce with oil prices edging higher but behind the October 2018 peak as fears of a slowing global economy weighed on market sentiment.

With the Hayne commission all but over, market participants have now pivoted towards the Australian federal election and the Labor party’s much debated franking credit refund policy. With national housing prices continuing on the downward path, expectations are that the RBA’s next move is down. Any cuts will see pressure on the $A which could bode well for offshore earners. With GDP growth slowing, any further intensifying of the housing market downturn would not bode well for growth, putting additional pressure on the Australian economy, potentially sparking a recession.

Source: Bloomberg, 1 January 2019 to 29 March 2019, returns in Australian Dollars. International Equities is MSCI World ex Australia Index, Australian Equities is S&P/ASX 200 Accumulation Index, Australian Fixed Income is Bloomberg AusBond Composite 0+ yrs Index, Global Fixed Income is Bloomberg Global Aggregate Bond Hedged AUD Index, Australian Bank Bills is Bloomberg AusBond Bank Bill Index, Emerging Markets is MSCI Emerging Markets Index, Gold is Gold Spot US$/oz, Australian Small Caps is S&P/ASX Small Ordinaries Index, US Small Caps is Russell 2000 Index, US Equities is S&P 500 Index, UK Equities is FTSE 100 Index, Japanese Equities is Nikkei 225 Index, European Equities is MSCI Europe Index, Chine equities is CSI300 Index.

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Exhibit 1: Index returns in March 2019 quarter

Exhibit 2: Global and Australian equity sectors March 2019 quarter performance

Source: Bloomberg 1 Januaty 2019 to 29 March 2019, returns in Australian Dollars. Consumer discretionary is MSCI World Consumer Discretionary Index / S&P/ASX 200 Consumer Discretionary Index, Financials is MSCI World Financials Index / S&P/ASX 200 Financials Index, Materials is MSCI World Materials Index / S&P/ASX 200 Materials Index, Healthcare is MSCI World Heath care Index / S&P/ASX 200 Heath care Index, Utilities is MSCI World Utilities Index / S&P/ASX 200 Utilities Index, Property is MSCI World REIT Index / S&P/ASX 200 AREIT Index, Consumer staples is MSCI World Consumer Staples Index / S&P/ASX 200 Consumer Staples Index, Information technology is MSCI World Information Technology Index / S&P/ASX 200 Information Technology Index, Energy is MSCI World Energy Index / S&P/ASX 200 Energy Index, Industrials is MSCI World Industrials Index / S&P/ASX 200 Industrials Index, Communications is MSCI World Telecommunications Index / S&P/ASX 200 Telecommunications Index.

Global economic perspectives – April 2019 3

Its Not You, It’s Me

The return of Goldilocks is welcome and sometimes, when an old flame comes back into your life, a wonderful new relationship blooms. But, more often than not, while things are good in the short term – all the reasons for the earlier break-up start to resurface. A bit of analysis suggests this maybe the case with the return of Goldilocks!

After so carefully explaining its position over an extended period, there are two reasons the Fed changed course so abruptly, and neither support a prolonged return of Goldilocks.

First, political pressure. President Trump has been applying the heat to Chairman Powell to back off on rate hikes, probably with one eye on the 2020 election. This is shades of President Nixon and Chairman Burns in the 70s: if the Fed goes soft but the economy continues to grow above trend, then the labour market continues to tighten, and the eventual outcome will be a burst of overheating, inflation and a Fed forced to send the economy into recession. Not a Goldilocks outcome.

Secondly: Fed tightening and trade wars have undermined the world economy, leading to (at best) subpar growth and (at worst) a global recession. This is trickier as even a subpar recovery after the GFC allowed years of corporate earnings growth which was turbo-boosted by low interest rates allowing multiple growth. It looks like markets have knee-jerked back into this world.

But there’s a difference between now and the long 2008 to 2018 rally. The long rally came after equity pricing had collapsed through the GFC. This time, markets are going straight for the Goldilocks rally before even pricing the downturn.

US equities rallied (and global risk followed) even as macro data and earnings forecasts deteriorated.

The world economy currently looks anaemic as there are plenty of recession warnings flashing these include poor global Purchasing Managers’ Index (PMI) results, disappointing global trade numbers and flattening yield curves. Corporate insiders who have reported their trades remain unconvinced. While they were happy to buy in the December dip, they have massively unloaded stock since.

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Corporate Insider sell and buy ratioS&P 500 (RMS)

Exhibit 4: The market is largely unconvincedInsiders have turned sellers after December’s low

Exhibit 3: The US has rallied despite forecasts deterioratingEconomic Surprises and the S&P 500

Source: Bloomberg, the Citi Global Economic Surprise Index shows recent global economic data surprising on the upside

Source : Washington Service, Bloomberg

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Exhibit 6: The indirect economic impact of the property downturnConsumers saving more and spending less

Exhibit 5: The direct economic impact of the property downturnHousing GDP contribution falling as are building approvals

Source: ABS Melbourne Institute

Source: ABS, Melbourne Institute. Forecast assumes constant income growth with the saving rate rising 3½ percentage points over the next 10 quarters.

Of course, the world economy could slip the noose as China is pumping liquidity into its market, western central banks have backed off tightening and throughout the quarter it seemed an outcome to the trade war between the US and China was possible. Recent data, too, is likely depressed by savage winter weather, Chinese holidays and the extended US government shutdown.

But even if the slowdown proves transitory, we think the Fed will be back to tightening into the end of 2019.

Australia

Unfortunately, the global slowdown has caught Australia at precisely the wrong point of its internal economic cycle. The economy slowed to a crawl in the second half of 2018 as property weakness compounded several years of stagnant household incomes. Australia now teeters on the edge of recession.

The property downturn is hurting the economy via two different paths:

1. directly, as weaker housing demand feeds into slower home building; and

2. indirectly, through the falling willingness of households to spend. Over the past few years households have lowered their savings rate to maintain spending; now that economic insecurity is rising, the savings rate looks set to climb which undermines spending.


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Exhibit 8: Capital expenditure risingBut non-mining and investment levels unlikely to be maintained:

Exhibit 7: Labour market is set to weakenBuilding approvals and construction employment falling

* Trend series leading by 12 months Source: ABS Melbourne Institute

* Nominal equipment, construction, intellectual property less mining. Gross Fixed Capital Formation, change in 2 quarter average Source: ABS, NAB, Melbourne Institute

The labour market itself looks set to weaken, as the surge in infrastructure jobs peaks and the housing and broader slowdowns become the main drivers of employment level.

With economy-wide activity soft, the recent decent rise in non-mining capital expenditure is unlikely to be maintained.

However there are a few bright spots for the Australian economy and assets (other than hoping for a swift and positive resolution of the trade fight).

First, as outlined last quarter, China has thrown the switch to stimulus. This will feed through to global growth (in general) and help commodity prices (in particular).

Secondly, the Government will continue to support the economy via large scale infrastructure projects as well as through broader fiscal largesse. With a desparate Government and Opposition facing elections federally, the spigots will be thrown open.

The generous ‘election’ budget was expected. The fiscal rabbits the Government pulled out of the hat has been matched by Opposition promises too, though their focus is on lower income earners getting tax cuts. Labor also will look to boost household incomes through rebalancing of labour market regulation, though this will likely take far too long to help 2019.


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Dot Shows Current CAPE

Exhibit 10: Falling earnings may undermine support in equitiesCycle adjusted Australian equity price appear relatively healthy

Exhibit 9: Australian corporate debtNon-financial corporate debt as a percentage of GDP is not stretched

Source: ABS, Melbourne Institute

Source: MSCI, ABS

Another positive for Australian asset markets is that neither corporates nor financial asset pricing are starting from a point where they are stretched. Corporate balance sheets are not very geared and price-to-earnings are mid-range rather than stretched. Naturally, falling earnings will undermine this support but at least the starting point is not terrible.

The Australian dollar is currently balanced between interest rates spread (expensive) and commodity prices (modestly cheap). Expect a significant fall in the Australian dollar as the economy skids.

A falling Australian dollar will cushion competitiveness and boost translation of foreign currency earnings for local exporters.


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Euro area Markit PMI: Manuafacturing Seasonally Adjusted

Euro area Markit PMI: Services - Business activity seasonlly adjusted

Exhibit 12: Manufacturing is suffering from the Asian slowdownBut services are hanging on

Exhibit 11: Europe more likely to suffer if Chinese growth slowsExports to developing Asia from US and Europe

Source: OECD, IMF, BEA, NBER

Source: Bloomberg, Markit

Europe

Manufacturing conditions continue to deteriorate in Europe. Europe’s greater exposure to Chinese growth, and also to the global auto sector, are both pulling down European growth. The European Central Bank (ECB) has already abandoned hopes of an early turn in the policy cycle.

Despite the weakness in the goods sector, the services sector has shown surprising resilience, with business sentiment and consumer spending turning up in the latest data.

While valuations remain attractive in Europe compared to the US, the next quarter is likely to remain heavy sledding.

UK markets remain too hard to call, with Brexit an ongoing swamp. The UK Government seems to be in the middle of losing control of the process as it falls increasingly into the hands of the EU. On the positive side, the odds of crashing out in a disastrous no deal Brexit seem to be receding (though nothing can be ruled out).

The foot dragging is increasingly forcing MPs to coalesce around May’s deal or ‘Remain’ (via a second referendum). The odds around hard Brexit/May’s deal/Remain are probably 5%/50%/45% - though fluid.


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Real Consumer SpendingCompensation Of Labour

Exhibit 14: Japan’s labour market continues to firmReal labour income and real consumer spending

Exhibit 13: China’s total social financing hit a record during the quarter But the fall in February is masked by Chinese New Year and stimulus should continue

Source: Trading economics, PBOC

Source: OECD, ESRI, MIAC

China

As outlined in our previous ViewPoints, China has unleashed a powerful liquidity cycle, with fiscal stimulus to follow. The wave of liquidity saw China equities surge and underpinned raw materials prices.

The course of policy and economic response will be hard to discern over the next month or two.

We expect the Chinese recovery and markets to retain their upward tilt.

Likewise, we expect a relatively modest outcome from trade negotiations. President Trump is under increasing pressure to land a deal, particularly following the breakdown in talks with North Korea; so while the headlines may look tough, the enforcement is not likely to match.

Japan

Japan has not been immune to the global manufacturing downturn. However, the labour market remains solid and wages continue to firm – suggesting that, despite cyclical difficulties, Japan is not about to return to secular deflation.


At the same time, rising capital efficiency has seen corporate earnings surge relative to capital expenditure. This has lifted return on assets, dividends and lowered gearing.

Japanese equities have not been rewarded for this, trading at multi-decade lows compared to other markets.

Japan is seen as a strong counter-cyclical bet. While Japan will not be immune, any serious economic dislocation will likely see the yen surge on safe haven flows more than insulating foreign investors. This mechanism is likely to be doubly potent for Australian dollar based investors.

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AUD/JPY

Exhibit 16: Japanese currency may strengthenAs it has in periods of weakness previously

Exhibit 15: Japan’s capital efficiency is surgingNonfinancial sector return on asset

Source: DataStream/Worldscope, NBER

Source: Bloomberg


Range of VanEck Vectors Exchange Traded Funds (ETFs) on ASX

ETF Name ASX code Index Management costs (% p.a.)

Australian Broad Based

Australian Equal Weight ETF MVW MVIS Australia Equal Weight Index 0.35%

S&P/ASX Franked Dividend ETF FDIV S&P/ASX Franked Dividend Index 0.35%

Australian Sector

Australian Banks ETF MVB MVIS Australia Banks Index 0.28%

Australian Property ETF MVA MVIS Australia A-REITs Index 0.35%

Australian Resources ETF MVR MVIS Australia Resources Index 0.35%

Australian Small and Mid Companies

Small Companies Masters ETF MVS MVIS Small-Cap Dividend Payers Index 0.49%

S&P/ASX MidCap ETF MVE S&P/ASX MidCap 50 Index 0.45%

International

ChinaAMC CSI 300 ETF CETF CSI 300 Index 0.60%

China New Economy ETF CNEW CSI MarketGrader China New Economy Index 0.95%

MSCI Multifactor Emerging Markets Equity ETF EMKT MSCI Emerging Markets Diversified Multiple-Factor Index (AUD) 0.69%

Morningstar Wide Moat ETF MOAT Morningstar Wide Moat Focus Index™ 0.49%

MSCI World ex Australia Quality ETF QUAL MSCI World ex Australia Quality Index 0.40%

MSCI World ex Australia Quality (Hedged) ETF QHAL MSCI World ex Australia Quality 100% Hedged to AUD Index 0.43%

FTSE International Property (Hedged) ETF REIT FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged 0.43%

International Sustainable Investing

MSCI International Sustainable Equity ETF ESGI MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index 0.55%

Global Sector

FTSE Global Infrastructure (Hedged) ETF IFRA FTSE Developed Core Infrastructure 50/50 Hedged into AUD Index 0.52%

Gold Miners ETF GDX NYSE Arca Gold Miners Index 0.53%

Australian Fixed Income

Australian Corporate Bond Plus ETF PLUS Markit iBoxx AUD Corporates Yield Plus Index 0.32%

Australian Floating Rate ETF FLOT Bloomberg AusBond Credit FRN 0+Yr Index 0.22%


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vaneck viewpoint · 1985 1990 1995 2000 2005 2010 2015 2019 4 qtr pp cont to gdp 12m% total housing...

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