David Bassanese

Given the strong growth in exchange traded funds (ETFs) in recent years – both globally and in Australia – it’s natural for many of the entrenched interests in the once cosy world of active funds management to cast dispersions to the extent they can.

Slowly but surely it seems, the “Trump trades” of earlier this year appear to be gaining traction once again.

Far be it for me to sound downbeat on the Australian economy, but I’m far from convinced we’ve necessarily turned the corner and “better times are ahead”.

Concerns over North Korea notwithstanding, the other major stand-off in global markets at present is between fixed-income traders and the Federal Reserve. Their point of contention? The outlook for US inflation.

Given recent commentary from the major central banks most important to us it is surprising that the Australian dollar has cracked the US80c mark over the past week. Market just don’t seem to be listening – or don’t believe – what central bankers are saying.

Investors get ready: we may be entering another “taper tantrum” period in which markets fret about rising interest rates and send equity markets southward.

How strong is the Australian economy really, and what does this mean for interest rates?

Reading the often dark headlines of our national newspapers, one could be forgiven for thinking that the retailing sector is a disaster zone for investors. There have been some high profile corporate failures over the past year, and the S&P/ASX 300 retailing sector has dropped like a stone since around August 2016.

Despite what the scare mongering newspaper headlines may suggest, Reserve Bank Governor Phil Lowe’s speech this week on house prices and household debt was more reassuring than alarming.

Global financial markets at present are caught between two possible scenarios for the year ahead: the so-called risk-on “Trump reflation” trades, and the risk-off “geopolitical” risk concerns. Each scenario favours a different set of investment ideas. But this does leave the question: which type of investment might do reasonably well under either scenario?

For a long while now, I’ve been predicting eventual weakness in the Australian dollar. Of course, given the Aussie battler’s stubborn resilience over the past year, it’s fair to say that call has been at best premature – and at worst, just plain wrong. But undaunted, I’m now sensing the $A is likely to face a serious test in coming months and may yet break to the downside, setting up a test of US70c by year-end.

The latest official measure of Australian house prices has again created the predictable angst over housing affordability. According to the Australian Bureau of Statistics, property prices rose 4.1% in the December quarter, and 7.7% over the year.

After a nice further leg up in prices since late January, Wall Street now looks over extended and a decent price correction of at least 5 to 10% could now be underway and possibly play out over the next month or so.

Phillip Lowe, the newly installed Governor of the Reserve Bank of Australia, is already clearly delineating his own particular set of priorities with regard to monetary policy. From recent RBA publications and speeches, Lowe has been unusually candid in outlining his thinking.

The performance of the US equity market through January was quite impressive considering the erratic nature of the Trump Presidency so far. While other global markets saw fit to take a little risk off the table – with bond yields easing and the US dollar falling – the S&P 500 added another lazy 1.8%.

So it seems that Donald Trump’s campaign rhetoric on trade is likely to be quickly put to the test. How countries respond to this antagonism remains to be seen, but the omens are not good. So far at least, Wall Street still seems to want to rally, preferring to focus on Trump’s promise of fiscal stimulus, rather than his threat to the international trade order as we know it.

Contrary to the usual fears that dominate the financial headlines, the Australian share market ended up posting reasonable performance in 2016, and the outlook – despite a sluggish economy – appears encouraging as we head into 2017.

2016 was another year of thrills and spills for global financial markets, and 2017 is likely to prove just as tumultuous.

I’ve got good and bad news for Australian investors as regards our fiscal outlook and credit rating.

So much for market concerns with a Trump Presidency.

Much as I would like to stir the pot by suggesting that the Reserve Bank of Australia should and will cut interest rates on Melbourne Cup day, I actually agree with market expectations that it’s now a relative long shot. What’s more, to my mind, the case for a further rate cut anytime soon is quite weak.

An emerging investment theme over the past few weeks has been a possible re-evaluation by central banks of their extra-ordinary monetary stimulus measures.

Although the greatest mining boom in Australia’s history is winding down, if all continues to go well with China we should soon start enjoying the next great boom – growth in Chinese consumer spending, and on food in particular. But for China’s economy to evolve toward more consumer spending and services, more of the benefits of its economic development it seems, will need to be better shared.

For many investors, the main focus in the United States economy is whether or not the Federal Reserve will raise interest rates in coming months. On this view the outlook seems binary.

To my mind the Chinese economy, the Australian dollar and iron ore prices are all defying gravity at present and all crucially dependant on Chinese policy leaders being able to keep pumping up a bubble in debt-fuelled public sector investment.

The Reserve Bank of Australia’s decision to cut the official cash rate has again typically had it fair share of critics. Some commentators suggest the RBA should not have cut rates as the economy is still travelling along relatively well, while others suggest the RBA has left its rate cutting efforts too late, which is why inflation is now too low for comfort.

The July 27 June quarter consumer price index report should lay the groundwork for a follow up interest rate cut by the Reserve Bank on August 2. But unlike some other economists, I’m less convinced the RBA will continue to cut interest rates much further heading into 2017.

With the Brexit vote looming large, markets are understandably on tenterhooks as to the outcome.

I have long thought that the next move in local official interest rates would be down. Although the Reserve Bank of Australia has of late appeared comfortably on hold, to my mind, persistent low inflation and an eventually rising unemployment rate (as the labour intensive home building boom slowed) would eventually force the RBA’s hand.

News this past week that the Reserve Bank of Australia is growing increasingly uncomfortable with the high Australia dollar suggests the barriers to another interest rate cut has been lowered somewhat further.

Investors are warned: we are only one or two economic report cards away from a potentially devastating reassessment of the global economic and financial market outlook.

Despite the fixation of many global central banks with the perils of deflation, there appear to be important supply-side dynamics taking place across the global economy which suggest either low inflation can co-exist with reasonable output and employment growth, or that inflation is set to take off and further help from central banks may not be required.

Among the many reasons being cited for the current global equity market sell-off, one jarring realisation is that the promise of more central bank stimulus does not appear to be working any more. Not only is it not working, it is arguably now detrimental to stock market health as near zero- and even negative – official interest rates undercut the ability of banks to make money.

As was the case last year, it is hard to see 2016 being anything other than a stock pickers market. Due to stretched equity valuations and a sluggish corporate earnings outlook, chances are that overall price growth for the Australian market will be fairly muted.

Although there are many reasons that might justify a corrective pullback in global equity markets, concerns over the Chinese economic outlook seems among the more flimsy. To my mind the Chinese economy is still enjoying an orderly economic slowdown and global market reactions to developments in Chinese financial markets are a gross over reaction.

After digesting the key economic news events of recent weeks, I’m left with the following impression: I’m pessimistic on our economy in the short-term, but optimistic on the longer-term challenges we face.

The Reserve Bank of Australia has told us to “chill out” this Christmas and right on course it duly decided to leave interest rates on hold at its final meeting of the year. The RBA still retains what I’d describe as a modest easing bias, with the Governor suggesting if interest rates move anywhere anytime soon it will be more likely down than up.

When prices in certain financial assets have already fallen a long way, it’s tempting to believe that the worst may be over. We all love a bargain after all. But buying something that is continuing to fall is described as like “catching a falling knife”.

To my mind, the $A appears on the cusp of its next major move lower. If you were not already a buyer of US dollars (such as through a $US ETF), the $A recent rally would have been a great time to get onboard.

Westpac’s decision to unilaterally lift home loan interest rates by 0.2% – and the likelihood that the other majors will now follow – has raised the chances that the Reserve Bank of Australia will counter the move by lowering official interest rates.