2016 2017 financial year in review

How far we’ve come. A year ago, the global economy was teetering on the edge. Global growth had stalled over the first half of 2016 and the UK had just voted to leave the European Union. Corporate profits were tumbling. Deflation risks were prevalent and concerns were rife that monetary policy had reached its limits in Europe and Japan.

Move forward twelve months and the progress is striking. The global economy is recovering, with broad-based improvement across countries. Real GDP growth in the G20 region has expanded at a 3.6% annualised rate in the first-three quarters of the financial year. Corporate profits are rebounding strongly, with S&P 500 earnings expected to rise 8% over 2016/17. Deflation risks have receded, with Japan and the euro area once again experiencing positive price growth. Across the OECD, consumer prices have risen 2.4% over the year to April, up from just 0.9% in 2015/16.

Central banks have now started to shift their rhetoric from the need for further stimulus to the prospect for normalising policy. The US has been at the vanguard, with the Fed raising rates by 75bps over 2016/17 and revealing a plan to start to reduce its balance sheet. Other central banks are also starting to contemplate a shift. After cutting rates to 0.25% in August 2016 and introducing further quantitative easing, the Bank of England is now actively debating whether the time has come to start to lift rates. Similarly, the Bank of Canada has signalled that a rate hike my not be far away, while the European Central Bank has also started to sound more hawkish.    

The improving economic environment occurred despite ongoing political uncertainty. While the election of President Trump in November was a significant surprise during the financial year, to date, his impact on the US economy has been limited. Trump quickly toned down many of his protectionist and antagonistic pre-election views. Changes to Obamacare have stalled in the Senate, while prospects for tax cuts or increased fiscal stimulus have also been held up.

Political uncertainty also remained prevalent in the UK. Nonetheless, the economy was remarkably resilient in the immediate aftermath of the BREXIT vote, emboldening Prime Minister May to call an early election; a move that dramatically backfired and left her with a minority government. Continental Europe bucked the trend towards populist politics, with Le Pen and Wilders suffering decisive defeats in the French and Dutch elections.

In Australia, the economy has continued to struggle in 2016/17. Real GDP growth has slowed to 1.7% over the year to the March quarter; the weakest growth seen since the financial crisis. Consumers have been weighed down by weak wage growth, while business investment has continued to be retarded by the mining investment downturn. After cutting rates in May and August 2016, the Reserve Bank of Australia has remained on the sidelines due to rising risks in the housing market. House prices accelerated over the first three quarters of the financial year, with gains of 12.9% over the year to March. APRA responded to the heightened risks by introducing further macroprudential measures to limit interest-only loans and tougher lending standards.

The improving global growth environment and recovery corporate earnings supported equity markets over 2016/17. With one day remaining in the financial year, the MSCI World ex Australia Index (AUD Hedged) has returned 20.7% over the financial year. European equities have outperformed (MSCI EMU Net return +25.6%), reflecting the strong cyclical rebound in the economy. In contrast, Australian equities have underperformed (S&P/ASX 200 Net return +14% during intraday trading on Friday), reflecting our relatively disappointing economic performance.

Improving growth, higher inflation and rate hikes by the US Federal Reserve drove 10-year government bond yields up by 81bps in the US and 58bps in Germany, while the impact of BREXIT and subsequent quantitative easing saw yields rise a smaller 38bps in the UK over the year. In Australia, bond yields rose around 61bps over the financial year. The increase in yields weighed on fixed interest returns, with the Barclays Capital Global Aggregate up just 0.6% (AUD hedged) over the financial year to date. In currency markets, the Australian dollar rose around 3.3% over the financial year to almost US$0.77.

Despite an uncertain political environment, improving momentum in the global economy over 2016/17 drove solid equity market returns. While we expect global economic growth to remain around its current pace, stretched valuations and a rising rate environment are likely to lead to much more muted equity returns in 2017/18, in our view, of around 5%.


Table 1: Financial market movements, 30 June 2016 - 29 June 2017*

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,419.7

15.3%

US

2.28%

81.1 bps

US Dollar Index (DXY)

95.55

-0.6%

Nikkei 225

19,971.5

28.2%

Japan

0.09%

30.8 bps

USD-JPY

111.95

8.5%

FTSE 100

7,350.3

13.0%

UK

1.25%

38.3 bps

GBP-USD

1.301

-2.2%

DAX

12,416.2

28.3%

Germany

0.45%

58.2 bps

EUR-USD

1.144

3.0%

S&P/ASX 200

5,735.5

9.6%

Australia

2.59%

61.2 bps

AUD-USD

0.769

3.3%



Economic Update
United States

Manufacturing data shows some softening in the US

  • Momentum in the manufacturing sector appears to have eased a little into the second quarter. Durables goods orders declined by more than expected in May, falling by 1.1% in the month after a drop of 0.9% in April. This was the largest monthly fall in 6 months and a steeper decline than the market expected. Orders for core capital goods (excluding defence goods and aircraft), an indicator of business spending plans, fell by 0.2% in May. Furthermore, a flash reading of the manufacturing PMI fell to a nine-month low in June (alongside a fall in flash services PMI). 
  • Consumer confidence firmed slightly in the US over the month of June after two months of declines according to the Conference Board, whose index rose to 118.9 from 117.6 in May. This beat expectations of a further decline in the month, and contrasted with the University of Michigan consumer survey published last week, which reported consumer sentiment falling in June.
  • Real GDP growth in Q1 was revised up from a 1.2% annualised pace to a 1.4% annualised pace due to stronger consumer spending.

Euro area / United Kingdom

Outlook for monetary policy takes a hawkish turn in the euro area and UK

  • There has been a shift towards hawkish sentiment amongst monetary policy makers over the past week; including comments from ECB President Mario Draghi on Tuesday stating that the deflationary pressures in the Eurozone had been replaced with reflationary ones. In addition, remarks from the BoE Governor Mark Carney regarding the potential removal of monetary stimulus going forward suggested a sharp contrast to his position just a week prior.


China / Japan

Unemployment ticks up in Japan despite signs of tightening labour market
  • Japan’s unemployment rate rose to 3.1% in May from 2.8% in April. This came despite ongoing tightness in the labour market, evidenced by the                   job-to-applicant ratio which ticked up to 1.49 in May, its highest level since February 1974.
  • Inflation in Japan was little changed in year-ended terms in May, with the headline CPI 0.4% higher over the year, matching April’s reading. Core inflation (excluding food and energy prices) improved, declining by 0.2% (year-ended) in May, from -0.3% in April.
  • Industrial production in Japan fell in monthly terms as expected in May, following strong monthly growth in April. Falls in transport equipment and business oriented machinery contributed to the decline of 3.3% in the month, from 4% growth in April. However, industrial production was 6.8% higher than a year earlier, accelerating from a 5.7% annual rate of growth in April.
  • China’s official manufacturing PMI surprised on the upside again in June, increasing to 51.7 from 51.2 in May on the back of a rise in the output and new orders subcomponents. The market had expected a fall in June, following softness in an independent manufacturing PMI survey published by Caixin and Markit, whose next release is due on Monday.

Australia / New Zealand

Credit growth remains steady in May
  • Total private sector credit growth was little changed in both monthly and year-ended terms in May. Housing credit growth remained strong, and while year-ended credit growth to housing investors has stabilised after accelerating in previous months, it continues to outpace growth in lending to owner-occupiers.

Sources: Thomson Reuters, Bloomberg, FactSet, ABS.




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