Market Update: May 2019

Global equities were the standout asset class in April, with the domestic share market also performing well. Fears of a disappointing earnings reporting season in the US were not realised, helping the US market maintain its upward trajectory (although events in the past week may undo these gains).

Australia delivered 2.4% in April, rising above 6,300 points on the back of consumer staples (+7.4%) and information technology (+7.3%). Retail sales have also been holding up well despite pressures on household spending, which spurred consumer discretionary up 5%.

Since late last year, share markets have rebounded with US shares up 25% to their recent high, global shares up 22% and Australian shares up 17% as last year’s worries about tightening monetary policy led by the Fed, global growth and trade wars have faded to varying degrees. Following such a strong rebound, some have said that maybe it’s now time to “sell in May and go away”, given the old share market saying. This is a reference to seasonal pattern in share markets, and whilst trends must always be considered with underlying fundamentals, they nevertheless provide a reasonable guide to the monthly rhythm of markets that investors should ideally be aware of. In simplistic terms, around May (and July in Australia) is perhaps not the best time to be piling into shares and around September to November is not the best time to be selling them. The following chart from Patersons Securities shows the current years’ performance (red line) versus seasonal averages (blue line), where you can see the average pattern throughout the year.

There is no guarantee that seasonal patterns will always prevail. They can be overwhelmed when contrary fundamental influences are strong, so they don’t apply in all years. However, from their December lows, shares – globally and in Australia – share markets have run hard and fast, and so are vulnerable to a short-term correction. Still, soft global growth indicators and the latest flare up regarding US and China trade could provide triggers.

Meanwhile, all eyes were on the RBA in April as they kept the cash rate at 1.5%, despite expectation of a cut following weak inflation data for the March quarter. The RBA is banking its hopes on a robust labour market to boost disposable income, but we see it as inevitable that rates will fall by the end of the calendar year. The basic problem for the RBA remains that they have been undershooting their inflation target of between 2-3% for about five years now. The longer this persists, the more it will lose credibility, and expectations of low inflation will become entrenched.

The slowdown in the housing market is expected to continue in the near term and remain a source of headwinds for Australian equities, but the government is determined to throw everything, including the kitchen sink at the housing market; just this week they announced their plans to act as guarantor for first home buyers who don’t have the standard 20% deposit. This scheme has also been backed by Labor, so it will come into force next year, allowing up to 10,000 applicants to purchase a first home with as little as 5% deposit, saving on large amounts of lender mortgage insurance normally applicable to those with less than the 20% deposit level. What would be ever better is to rid first home owners with the awful state tax being stamp duty, but given such reliance on this by the states, it’s unlikely this will ever be removed.

Recently, the US/China trade war has reared its ugly head, after what appeared to be good progress made earlier this year. Trump hit the tantrum button and tweeted that tariffs on US$525bn of imports for China will rise from 10% to 25%. This has been met by share market volatility, but our base case remains that a deal will get through and that this is all likely a bit of ‘Art of Deal’ stuff from Trump to sound tough and eventually get what he wants. Leading into a US election campaign, he will defiantly want to be able to spruik about a new deal.

Under the latest announcement, the US will increase the previously delayed tariff hike from 10% to 25% on several hundred Chinese goods imported into the US. If fully implemented, this would take the average US tariff rate on imports to around 7.5%, which is significant (albeit minor compared to the 20% tariff hikes of 1930.) See the next chart.

Fortunately, Australian’s aren’t having to pay higher taxes on imports like Americans, but the main risk is that we are indirectly affected if the trade war is not quickly resolved, which could drag down global growth, weighing on demand for our exports, leading to unemployment pushing higher than our 5.5% forecast for year end. The risk of this adds, in turn, to pressure on the RBA to cut interest rates, although we think they will do that anyway once the election is out of the way.