Global Market

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EXPERT OBSERVER
There is lots of talk about when the next major economic downturn will be. This interest seems to have been particularly noticeable over the last week or so given the ten-year anniversary of the failure of Lehman Brothers which helped usher in the worst phase of the Global Financial Crisis (GFC), which naturally prompted the question of when the next one will be.
But it’s also been given impetus as the current US bull market and economic expansion are approaching record territory in terms of duration and given the threats from a US driven trade war. The historical experience indicates that share market downturns are much deeper and longer when there is a recession, particularly in the US economy.
So, whether a recession is imminent or not in the US, and more broadly globally, is critically important in terms of whether a major bear market is on the way. Of course, no one really knows for sure (despite many claiming they do!). But certain indicators help provide some guidance as to the risks. This note looks at five charts to monitor in terms of the state of the global economy.
Chart #1 – Global business conditions PMI Global Purchasing Managers Indexes (PMIs), which are surveys of purchasing managers at businesses in most major countries, provide an excellent and timely guide to the state of the global economy. As can be seen in the next chart, while they are down from their peaks of earlier this year they remain very strong indicating that global growth remains strong. This is particularly the case in the US. Quite clearly a sharp downturn, as occurred going into the GFC, would be a concern for global growth but so far so good.
<img src="https://www.urban.com.au/images/2018/9/20/AMP%201.JPG" alt="">
Chart 2 – Global inflation Most major economic downturns are preceded by a rise in inflation to above central bank targets resulting in aggressive monetary tightening. The period prior to the GFC was something of an exception in terms of core inflation, ie inflation excluding food and energy. But average headline inflation rose to around 4% across the US, the Eurozone and Japan at the time as energy prices surged and the run up to the GFC was associated with tight monetary policy in the US and Europe (where the focus at the time was on headline inflation). Source: Bloomberg, AMP Capital At present, core inflation in major global economies is benign. In the US core inflation is around 2%, which is the Fed’s target and headline inflation is falling. Inflation in China is also around 2%, which is below the Government’s 3% target/forecast. And inflation in the Eurozone and Japan, whether headline or core, is below both the European Central Bank’s and the Bank of Japan’s 2% targets. While a lack of spare capacity in the US means that the Fed will continue raising interest rates to more normal levels, with inflation around target (and other signs of
<img src="https://www.urban.com.au/images/2018/9/20/AMP%202.JPG" alt="">
Chart 3 – The US yield curve The yield curve is a good guide to the stance of monetary policy. When short-term interest rates are low relative to long-term rates businesses can borrow short and lend (or invest) long and this grows the economy. But it’s not so good when short rates are above long rates – or the curve is inverted. And an inverted US yield curve has preceded US recessions. So, when it’s heading in this direction some start to worry. As a result, it’s worth keeping an eye on and it’s our third chart. But there are several complications to allow for. First, there are several versions of the yield curve. The traditional yield curve based on the gap between 10-year bond yields and the Fed Funds rate has flattened but only to 1.2%. Moreover, a shorter yield curve based on the gap between 2-year bond yields and the Fed Funds rate predicted past recessions like the longer yield curve but has actually been steepening lately which is positive. So our chart includes both yield curves. Both are yet to go negative as occurred prior to the last three US recessions. Source: NBER, Bloomberg, AMP Capital But there are several other things to allow for. The yield curve can give false signals (circled on the chart) and the lags from an inverted curve to a recession can be around 15 months. Various factors may be flattening the traditional yield curve unrelated to economic growth expectations including low German and Japanese bond yields holding down US yields and higher levels of investor demand for bonds post the GFC as they have proven to be a good diversifier to shares in times of crisis. On top of all this, a flattening yield curve caused by rising short term rates and falling long term-rates is more negative than a flattening when both short and long-term rates go up like recently. So all up the yield curve is worth keeping an eye on but both its long term and short term versions really need to go negative before getting too concerned. So far so good. Of course, it’s worth keeping an eye on other measures of US monetary tightness as well – for example past US recessions have been preceded by the Fed Funds rates being well above inflation and nominal economic growth whereas it’s still a long way from either now.
<img src="https://www.urban.com.au/images/2018/9/20/AMP%203.JPG" alt="">
Chart 4 – The US dollar Moves in most currencies are usually only really of relevance for the country that the currency belongs to. The US dollar is a clear exception to this mainly because debt is often denominated in US dollars. In particular, emerging countries tend to have a lot of US dollar denominated debt so when the $US falls in value versus their own currency, servicing that debt gets cheaper but when the $US goes up in value, servicing that debt gets more expensive. This has been the case lately with the rising US dollar against most currencies including emerging market currencies as shown in our fourth chart, adding to problems in various emerging countries. Further strong gains in the US dollar as the Fed continues to hike risks worsening emerging market problems and the risks that this poses to global growth (as the emerging world is around 60% of global GDP). By contrast if the US dollar moderates, the pressure on emerging countries is likely to recede.
<img src="https://www.urban.com.au/images/2018/9/20/AMP%204.JPG" alt="">
Chart 5 – World trade growth In recent times there has been much debate as to whether the era of globalisation is coming to an end resulting in a peak in world trade. This could be for somewhat benign reasons as services become an ever-greater share of economic activity and manufacturing becomes less labour dependent. But it could also be due to rising protectionism with US policies under Trump a big threat. It’s early days so far with only about 12% of US imports being subject to increased tariffs for an average tariff increase across all US imports of just 1.6% (after the latest tranche is implemented). This is a long way from 1930 that saw all US imports subject to a 20% tariff hike and other countries do the same. While we still see a negotiated solution, it may not come till after the US mid-term elections. Global trade growth has picked up over the last two years but its recently started to slow a bit. It’s too early for this year’s trade conflict to show up in trade data but it’s worth watching this chart as slower global trade growth would pose a threat to global economic growth. Source: CPB World Trade Volume Index, AMP Capital Concluding comments On balance these indicators suggest the outlook remains okay. Perhaps the greatest near-term risks are around the US dollar and Trump’s trade war. Beyond this, cyclical indications are still okay. And while we haven’t had room to fit it in here the signs of cyclical excess that normally precede major economic downturns – eg, very strong wages growth and a high level of cyclical spending (consumer durables, housing and investment) as a share of GDP – aren’t particularly evident in the US and are a long way from being evident in other major countries.
<img src="https://www.urban.com.au/images/2018/9/20/AMP%205.JPG" alt="">Dr Shane Oliver is the Head of Investment Strategy and Chief Economist at AMP Capital
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Five charts to keep an eye on regarding the global economy: Shane Oliver

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The number of people with US$500 million or more in net assets in Asia is going to overtake North America in the next five years, according to new research.
Knight Frank’s The Wealth Report analyses the population of the super wealthy, which is terms ‘demi-billionaires’.  
According to wealth data specialists Wealth-X, the amount of demi-billionaires based in Asia is set to rise to nearly 3000 in the next five years pushed by strong economic growth and rising asset prices.
However, in terms of country, the US will still dominate this segment of the population with its current tally of 1,830 set to rise to nearly 2500 in the next five years.
<a href="https://www.propertyobserver.com.au/images/2018/9/7/wealth-spotlight.jpg" target="_blank">Click here to enlarge.</a>
<img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/9/7/wealth-spotlight.jpg" alt="">
Australiasian demi-billionaires are also set to increase 29% from 70 to 90 by 2022, says Knight Frank’s Head of Residential Research, Australia Michelle Ciesielski.
“The methodology for projecting this increase looks at GDP growth, the performance of equity markets and other investments, as well as wealth distribution trends. Currency also plays a significant role.
“The continued increase in wealth in Australasia is being encouraged by stronger local economic conditions and performance of property investments over the past several years. In addition, international drivers including equity and bond performance has spurred on confidence.”
Wealthy investors are driving the demand for prime property, with Australia a top target, says Knight Frank’s Head of Residential, Australia Sarah Harding.
“We need to look on this global platform to truly appreciate the level of sophistication expected by the world’s wealthiest, including where they spend and invest; where they enjoy their downtime; and where they educate their children – now, and in the future.
“For the first time, Australia is delivering super-prime projects like One Barangaroo in Sydney and The Muse in Melbourne to the market – on par with world-class developments in established global cities such as London and New York.”
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Australasian demi-billionaires to increase by 29% over next five years

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EXPERT OBSERVER
However the minutes of the Monetary Policy Meeting of the Reserve Bank Board contain increased confidence for the consumer outlook.
The themes we have seen in previous minutes around a continuing global economic expansion tempered by some policy induced slowdown in the Chinese economy remain. As before, the issue around international trade is highlighted as a source of uncertainty for the global outlook. The forecasts for the Australian economy which were set out in the recent August Statement on Monetary Policy are described as largely unchanged.
Of most interest in the commentary around the economy relates to a more confident assessment of the risks around the consumer. “Recent data on wages growth and expectations of a further tightening in labour market conditions had provided more comfort that household income growth would continue to increase gradually and support the outlook for consumption”. In previous minutes, the outlook for household spending was described as a source of uncertainty. In these minutes, the Board points out that “the more recent increase in minimum wages, the announcement of future tax cuts, and expectations of a further tightening in labour market conditions had reduced some of the uncertainty around the outlook for consumption.”
Commentary around the housing market is unchanged with Sydney and Melbourne house prices having “declined further in July and across a broad range of properties”. No real outlook is provided, although the Board continues to point out that “some further tightening of lending standards by banks was possible”.
The investment outlook remained positive, although non-mining business investment was expected to grow at a more moderate pace than over the previous year. The pipeline for building construction work was still reasonable supporting the growth outlook in the near-term but, by implication, slowing further out.
The minutes confirm the forecasts in the August SoMP which anticipate both headline and underlying inflation failing below 2 per cent to 1 ¾ per cent in 2018. This downward revision to the previous 2 ¼ per cent and 2 per cent respectively is attributed to some one-offs on childcare, TAFE and car registration fees and utilities prices. Appropriately, Board Members note that there is a risk that the recent decline in wholesale electricity prices could have more persistent effects. Certainly Westpac is of that view.
Finally, as expected, the minutes emphasise that reducing the unemployment rate and returning inflation towards to the mid-point of the target remain the necessary conditions to support higher rates. It is reiterated that the next move in the cash rate would more likely be an increase rather than  a decrease.
Conclusion
Today Westpac released an update to its forecasts, extending them out to the end of 2020. We anticipate the cash rate remaining on hold through 2018, 2019 and 2020. Factors which we consider important in this profile are: a steady weakening in the housing market through 2018 and 2019, low inflation, benign wages growth, and clear signs of a slowdown in the world economy.
The Minutes mention most of these factors but appear to be overly hopeful that economic activity and income growth will be sufficient to justify a rate hike at some point.
Bill Evans is the Chief Economist for Westpac
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Overly hopeful RBA board minutes contain few surprises: Bill Evans

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EXPERT OBSERVER
For the 12 months to 30 June, equity markets posted solid gains both in Australia and offshore, up 13.7% and 15.4% respectively.
Returns were also positive across other asset classes such as direct property and infrastructure, and bond returns, although modest, were much stronger than the previous year.
Overall, global growth conditions helped to drive earnings and although the US Fed continued to raise rates over the past 12 months, monetary policy conditions both in the US and globally remained accommodative.
In this article, we look at what’s been driving these returns and consider the outlook for returns over the medium term.
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2017/18 was characterised as a year of two halves where volatility featured heavily over the second half.
Equity markets were particularly weak at the start of 2018 due to concern that inflation was emerging in the US and that growth had reached a cyclical peak.
These fears quickly settled, and the markets were able to recover but volatility resumed on the back of rising geopolitical tension, specifically the threat of a global trade war between the US and China.
<img src="https://www.urban.com.au/images/2018/7/18/AMP%20cap%20p1.JPG" alt="">
Looking forward, we are mindful that the market may be underestimating inflation and the threat of additional interest rate increases in the US.
We are coming to the end of a long expansion period and there is uncertainty as to how far interest rates can rise before they become negative for equities and how central banks will respond once inflation shows signs of life.
These factors alongside ongoing geopolitical uncertainty suggest that trading conditions could be less supportive over the year ahead and returns in this environment are likely to moderate.
Volatility will continue to feature over the medium-term and while often viewed in a negative context, it can create trading opportunities for our super portfolios that have a longer-term investment horizon.
That said, we are mindful of building portfolios that can better withstand downside volatility. Not only does investing across a broad combination of assets achieve this but actively managing within and across asset classes can also deliver a better risk and return outcome.
Deborah Alliston is the head of Multi-Asset Portfolio Management for AMP Capital in Sydney, Australia.
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How did property stack up as an investment option this past financial year: Deborah Alliston

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The future is looking "very bright" for global construction markets with synchronised activity upswing in Australia, the USA, Europe, Japan and China, according to a new survey.
Turner &amp; Townsend’s International Construction Market Survey 2018 shows that of the 46 global markets examined, 21 expect to warm up, 23 are set for stability, and only two are likely to cool.
Sydney and Melbourne are considered hot, Brisbane is lukewarm and Perth is cold. 
Global construction costs are expected to rise 4.3% in 2018, following a 4.1% increase in 2017.
New York repeated its ranking taking the number one spot for the most expensive place to undertake construction activities.
San Francisco, Hong Kong, Zurich and London subsequently followed. Sydney was again positioned at number nine, with Melbourne ranked at 19, Brisbane placed at 21 and Perth at 23.
Sydney construction costs are expected to increase by 4% in 2018, the same as 2017.
Melbourne will rise by 2% to 4%, Perth is expected to increase by 1.5%, and Brisbane to ease by 1% to 3% overall for 2018.
Global construction costs are set to rise 4.3% in 2018, following a 4.1% increase in 2017.
The survey analyses input costs, such as labour and materials, and charts the average construction cost per square metre for residential, commercial, industrial, retail, hotels, hospitals, schools, car parks and airports (buildings only).
 <img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/5/23/Crane%20and%20building%20construction%20site%20against%20blue%20sky_Med%20Res.jpg" alt="">
Gary Emmett, economist for Turner &amp; Townsend, says 2018 was set to be the strongest construction year that we have witnessed since the Global Financial Crisis (GFC), which is boosting optimism.
"The GFC cast a black cloud over the industry for many years, however that has now lifted," Emmett said.
"Since the GFC, growth amongst the major advanced economies averaged half the pace of the previous 10 years.
“Synchronised global growth looks set to increase the construction industry activity, driven by Australia, the USA, Europe, Japan and China."
The Middle East and UK are notable exceptions to experiencing an upswing. 
He added that Federal and state governments in Australia are planning to invest over $50 billon in significant infrastructure projects over the next decade, including Western Sydney Airport. Major road and rail projects are ramping up, boosting the local economies and demand for trade skills.
"Tunneling is a focus. Sydney Metro Rail is delivering 15 kilometres of tunnels, and Westconnex, a mostly underground 33 kilometre roadway, is underway. 
"Melbourne is starting the West Gate Tunnel project and Monash freeway upgrade, while Queensland is delivering Cross River Rail.”
The report noted Sydney and Melbourne are witnessing strong growth in financial services, and real estate, with 17% jobs growth during the year. Unemployment has fallen to 5.4%.
Sydney residential construction spend is up by 47% since the 2016 international report.
Over the same period construction costs are showing an average 11% increase, while non-residential construction (hotels, offices and retail) activity was up by 11%.
The Melbourne residential construction market grew by 17% during the same period, showing an average cost increase of 4%, while non-residential market activity rose by 17%.
Brisbane’s residential construction market increased by 12%, showing an average cost upswing of 9%. Non-residential market activity also grew by 12%.
Perth’s residential construction market fell by 31%. Construction costs were also down by 2% and non-residential construction activity fell by 8%.
<a href="https://www.propertyobserver.com.au/images/2018/5/23/CONSTRUCTION%201.jpg" target="_blank">Click here</a> to enlarge: 
<img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/5/23/CONSTRUCTION%201.jpg" alt="">
<a href="https://www.propertyobserver.com.au/images/2018/5/23/CONSTRUCTION%202.jpg" target="_blank">Click here</a> to enlarge:
 
<img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2018/5/23/CONSTRUCTION%202.jpg" alt="">
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Global construction activity the strongest since GFC, says new survey

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<img src="https://counter.theconversation.edu.au/content/68060/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
It came as no surprise that the Reserve Bank left the cash rate at its historic low 1.5 percent on Tuesday. Governor Philip Lowe’s statement contained most of the boilerplate phrases: “the economy is growing at a moderate rate”. “Labour market indicators continue to be somewhat mixed.” “Measures of household and business sentiment remain above average.”
But it was the following paragraph that piqued my interest:
“Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 has been helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are assisting the economy to make the necessary adjustments, though an appreciating exchange rate could complicate this.”
Not to go all deconstructionist, but it’s worth parsing those words carefully. “Low interest rates have been supporting domestic demand”: i.e. the usual effect of cheaper borrowing costs has worked. 
<a href="/images/2016/11/04/Screen%20Shot%202016-11-04%20at%209.14.33%20AM.png" target="_blank">Click to enlarge</a>
<img src="/images/2016/11/04/Screen%20Shot%202016-11-04%20at%209.14.33%20AM.png" alt="">
The “lower exchange rate has helped the traded sector”: i.e. a lower dollar makes our exports cheaper for foreigners to buy. 
“An appreciating exchange rate could complicate this” underlines the long-held concern the RBA has in the Aussie dollar rising above about 75 US cents. This could happen, for instance, if the US Federal Reserve fails to raise rates as aggressively as markets expect, or if there is a continued flight out of Europe to Australia’s relative safety and positive interest rates.
The fact that the RBA is so concerned about this highlights how interconnected Australian monetary policy is with international events and policy. And in a world as uncertain as the one we are in, it’s dangerous to make strong predictions about the future course of monetary policy.
The most interesting sentence of all in Dr Lowe’s statement is:
“Financial institutions are in a position to lend for worthwhile purposes.” 
This is a comment about the ability of Australian banks (essentially the big four) to take risk. That is, a comment about the strength of their balance sheets. Assuming it’s accurate, this is both comforting and important. If business and consumer confidence do pick up further, and businesses want to invest, then they should be able to borrow to do so, according to Dr Lowe.
Meanwhile, building approvals fell sharply in September, down 8.7 percent on a seasonally adjusted basis – well beyond market expectations. Housing approvals were up slightly, 2.3 percent, but apartment approvals fell 16.3 percent. That sounds bad, but the apartment sector is volatile, and there have been concerns about oversupply – especially in Brisbane and Melbourne. Still, overall approvals are down 6.4 percent on last year.
That’s no good for housing affordability, but it also has a monetary policy implication. If it fuels a continued escalation in housing prices – especially in Sydney and Melbourne, then the RBA may well feel constrained to cut interest rates in the event that they otherwise might want to.
There was mixed news about the Australian services sector – the largest and most economically important in the economy – with the Australian Industry Group’s Performance of Services Indicator up 1.6 points to 50.5. This is well below levels of around 56 before the financial crisis, and below the 54s recorded in mid 2015.
The ABS reported Thursday that the trade deficit fell 35% in September to A$1.227 billion, in seasonally adjusted terms. This was largely due to the recent increase in commodity prices – something over which Australia has no control, and which are devilishly difficult to forecast going forward.
Overseas, there was positive news from China where both the official Purchasing Managers’ Index (PMI) and the unofficial Caixin index came in at 51.2, ahead of expectations and indicating expansion (as numbers above 50 do). The official PMI is more relevant for large, state-owned enterprises, while the Caixin index is useful for understand medium-sized business. Often they don’t align, so this may be an early signal of a general positive trend. Stay tuned in coming months.
In fact, that will depend in no small part on whether Dr Lowe’s comment about banks in Australia having the balance-sheet capacity to lend is true in China. There are serious concerns about household indebtedness and the quality of bank balance sheets in China. A sustained increase in the PMI might be a hint that things are not quite so bad. September, however, is one datum point.
The Australian economy continues to show some positive signs, but there are pockets of weakness and cause for concern every month. And these aren’t concentrated to one sector, like the mining sector. In recent months there have been (and continue to be) legitimate concerns about: the labour market, business confidence, consumer confidence, inflation, growth, and more.
It looks like it will be some time before we see a consistent run of data indicating that we should have confidence in a genuine recovery.
Richard Holden is professor of economics and PLuS Alliance Fellow, UNSW Australia and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/richard-holden-118107" target="_blank">here</a>.
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