Following a very strong fourth quarter of 2016, international equity markets have started the year on a positive note. However, due to a strong Australian Dollar (AUD) which rose by 5.2% against the US Dollar (USD), results were weak in unhedged terms. The MSCI World ex Australia Index returned +1.4% in hedged terms and -2.4% in unhedged terms. The S&P/ASX 200 Accumulation Index outperformed unhedged international equity markets but still lost ground, returning -0.8% for the month. Global bonds markets were weaker, underperforming the Australian bond market which was positive after a disappointing fourth quarter.
In the US, data continues to point to the strength in the economy. December unemployment was 4.7% and although this reading was 0.1% higher than the month prior, other indicators such as the ISM US Manufacturing PMI point to economy-wide resilience and continued expansion in the manufacturing sector. The University of Michigan’s Index of Consumer Sentiment remains elevated also and a key factor here seems to be optimism around Donald Trump’s recent election. Trump was inaugurated on 20 January and quickly issued a number of executive orders, one of the most significant for Australia was the withdrawal of the USA from the Trans-Pacific Partnership (TPP). The TPP is now an 11 country agreement, a key feature of which is reduced trade barriers among member countries. The agreement, which is not yet in force, should still provide material benefits to Australia. However, as the US was the agreement’s largest member, news of its withdrawal is a large blow. January also saw tensions grow between the US and one of its largest trading partners, Mexico, after Trump signalled his desire to renegotiate the North American Free Trade Agreement (NAFTA).
In terms of the US equity market, the S&P 500 Index returned +1.9% in USD terms, and the Dow Jones Industrials Index returned +0.6%. Although this was a weaker result, the Dow reached a record high during the month, exceeding 20,000 for the first time.
In the UK, Brexit related news continues to dominate sentiment. UK Prime Minister Theresa May confirmed that the UK would be leaving the single market. The UK would not be ‘half in, half out’ of the EU. This seemed to spark a strong rally of the Pound, which rose by more than 3% against the USD over the course of the day. The process of Brexit later encountered a setback after the Supreme Court ruled that an Act of Parliament is required in order to trigger Article 50 (the legal document concerning withdrawal from the EU). In terms of economic data, GDP growth (estimate) for the December quarter was +0.6%, beating expectations. This may seem surprising in the wake of Brexit, though it is thought that any negative effects of Brexit will play out for years to come. In Europe, manufacturing data continues to point to strength, while monetary policy remains accommodative with the European Central Bank (ECB) deciding to leave rates on hold. The UK equity market ended the month 0.6% weaker while the European market was 1.7% weaker.
In the Asia-Pacific region, China’s GDP growth data exceeded expectations at 6.8% for the year to December. Although GDP growth has moderated in recent years, China continues to be one of the fastest growing economies in the world. In Australia, inflation was 0.5% for the December quarter, lower than expectations of 0.7%. This brought yearly inflation to 1.5%, well below the Reserve Bank of Australia (RBA) 2-3% target. This led to markets quickly pricing in lower long term inflation and increased probability of an interest rate cut in 2017.
Economic data continues to show strength in major economies such as the US and China with the January profit reporting season quite positive so far. However, markets are set to be dominated by policy announcements as much as economic and company data with all eyes on the US after Donald Trump’s inauguration. Markets will be sensitive to the level of stimulus created through Trump’s policies, but markets are likely to react adversely if future stimulus falls short of market expectations.
We are conscious of these downside risks and continue to monitor economics and markets closely. However, market uncertainty around future US policy also creates the potential for upside, so all potential outcomes need to be considered. We look forward to updating you on events in the next monthly newsletter.
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