Monthly economic update with MLC, February 2018

Funds Management

by Clive Tompkins

MLC Senior Economist Bob Cunneen discusses latest economic measures and market moves with Head of Investment Communications, NAB Asset Management, Jason Hazell.

Jason Hazell:
Welcome to the monthly economic update, I'm joined again by Bob Cunneen. Welcome, Bob.

Bob Cunneen: Thanks Jason.

Jason Hazell: So it seems like for the last 12 months we've been talking about strong markets and continual low volatility. Just in the last few days we've seen a real reversal of that, and markets have fallen, and we've seen quite high volatility.

Bob Cunneen: Yeah, so the first week in February has basically reversed all the gains that we saw in January for the American share market. And what you've seen is an extraordinary reversal.

So if we go back to January, the American share market was up 5%, and what we saw essentially in the first week of February was a complete wipe out of that performance. And there was a couple of factors in play, in particular what we're seeing is rising bond yields in the United States. So we've had very strong employment reports there, low unemployment, but also very sharp lift in wages growth.

And with that, there's an increase in the inflation risk in the United States. And a concern is that the American Central Bank will probably need to raise interest rates aggressively over the next coming years, so that's a concern for Wall Street.

Jason Hazell: So is that really the essence of what's happened here, that the equity markets have now started to price in what the US Fed has been saying is going to be happening?

Bob Cunneen: Yes, exactly, because Wall Street was running on the low inflation story, so a combination of globalisation, technology, keeping wages down. But what we're now starting to see is that the old supply demand relationship return. So if you've got low unemployment, you've got strong demand in terms of jobs growth and a limited amount of supply, wages, or employees, have more bargaining power. And because of that, the inflation risk starts to pick up.

Jason Hazell: Right, so wage pressures start to increase, inflation pressures start to increase, the Fed potentially has to do more, and the market has started to factor that in?

Bob Cunneen: Exactly. So, essentially for the share market, the bond yield is the key discount rate. So if we're pricing cash flows over the longer term, the bond yield is that key point as a reference for the worth of those cash flows.

Jason Hazell: Okay, now turning to Australia, it's been a slightly different story, because in the month of January it was a bit weaker. How have you seen that play out, particularly through the volatile period the last few days?

Bob Cunneen: Yeah, so the Australian market has been disappointing this year, so January we had a small fall. And that largely related to the, essentially the strong Australian dollar, plus the rise in global bond yields. So our market was sensitive to that. In particular, real estate investment trusts, and the utility sectors showed that impact.

Now in February, when we've had this Wall Street turmoil, we've gone down in sympathy with what's happening. So, year to date our market has particularly disappointed, being down about 4% so far.

Jason Hazell: And what's been the reaction with the Aussie dollar during the last six weeks, but particularly the last week?

Bob Cunneen: Well, in January our currency rose, because we had a strong commodity story going on, iron ore, oil prices, copper prices, were going up. But since Wall Street has taken this sharp reversal, the Australian dollar's come back from 81 cents back to 79 cents.

So, when we see an environment where risk is taken off the table across the globe, the Australian dollar is sensitive to the downside.

Jason Hazell: Okay, well, do you think that over the coming months we'll see a higher volatility market now, given all of the uncertainty that we see?

Bob Cunneen: Yes, because essentially, for the last year in particular, Wall Street has been a one way bet in terms of rising. What we're now starting to see is more sharper swings in Wall Street, as it comes to terms with this rising bond yield interest rate environment. And because of that it's no longer a one way bet, it's a much more challenging environment for investors.

Jason Hazell: Great, well many thanks for your time today.

Bob Cunneen: Thanks very much Jason.

Jason Hazell: And if you'd like any further information on what we discussed you'll find it on our website. Thanks for joining us.