Market Watch

There are jitters building in the domestic and global markets that are catching my attention.

These are the reactions to the Royal Commission, uneasiness about the US 10-year bond yield crossing 3 per cent and moving higher still, and global growth showing retrospective strength but future indicators showing signs of slowness. These are all leaving markets finely balanced.

The granular

Tuesday saw Australia’s inflation data release, which we covered on the day – but a quick reminder of the key take-outs.

• ‘Trimmed mean’ CPI rose 10 basis points to 1.9 per cent, its highest read since the September quarter of 2015 and a break-out of a four-quarter run at 1.8 per cent.
• Core sub-sectors remain stable while the likes of health and education shifted up, pushing the CPI read back toward the RBA’s target band of 2 per cent to 3 per cent but still 10 basis points below.

Conclusion: The print is unlikely to shift monetary policy anytime soon, however it’s moving in the right direction on a long-term projection view.

What’s piquing my interest?

The macro environment is at an interesting inflection point: growth is strong globally, confirmed by the IMF and the World Bank in the past two weeks, finally catching up on consensus that global growth in 2018 will be around 4 per cent.

However, leading indicators are starting to show signs of slowing. Activity indicators such as manufacturing, housing, discretionary spending, labour and lending have slowed since January.

Now although some of these indicators don’t feed into GDP directly, they are a broad representation of a country’s underlying economics on a forward-looking basis.

The slower pace is not surprising. The global growth story has been fairly linear over the past two and half years, but this is actually historically abnormal rather than the norm – growth tends to move in waves.

Slower-paced periods, if we look at the past 20 odd years, tend to be over a three to five-month period. There have been approximately 12 since 1997, 13 if we take the latest leading indicators.

This suggests we may have entered a ‘slowing phase’ in late February (Australia’s employment change was downgrade in February as was construction and lending).

We must stress that of the 12 periods of ‘slower paced’ growth, only twice did the globe enter a ‘dreaded’ recession. And, as we are all aware, Australia never has during this period.

So, I am not suggesting we are facing the prospect of a recessionary period, because things are still expending solidly – but just not at the same pace as the past few quarters.

The outlook for markets

Therefore, how would one expect this period to look for markets? Equity and credit markets tend to ease over this period (which has been seen since February) compared to their fixed income peer.

Historically, US fixed income rates have fallen during a slowdown period, however in 2006 this wasn’t the case. 2018 looks like it might follow this route, with the US Federal Reserve still forecasting two rate rises over the coming eight months, with the possibly three but if risks build funds will flow here.

What’s most interesting is that emerging markets have outperformed developed markets during these period; the caveat is that this has occurred just over 50 per cent of the time.

The economics

These slowdown periods are unsurprisingly met with gradual downside ‘surprises’ from central banks and the like.

The Reserve Bank is positioning itself for a downgrade of its 2018 GDP outlook, which at the last Statement of Monetary Policy sat at 3.25 per cent for 2018. Language in the latest minutes suggest this may be revised down to 3 per cent, which is still robust but below original expectations.

I will be watching the statement from the cash rate meeting next Tuesday for further insights.

Retain the view that 2018 will be the peak of the growth cycle: it may take slightly longer than expected. This is a positive for equities and credit over the year.

However, they might have to grind higher rather than naturally appreciating like they did in the back-half of 2017, which is a longer-term positive.

But I’m aware that on the short and near-term basis the slowdown phase may cause a negative drift.