The past month was positive for Australian equities with the S&P/ASX up 3.15% over the past four weeks. Banks drove gains as they rebounded in recent weeks following several weak months on the back of the Royal Commission.
It was a bleaker month elsewhere as trade tensions escalated, with the US and China initiating tariffs for US$34 billion in goods, with an additional US$16 billion expected to go in effect shortly and a further US$200 billion being threatened. The US S&P 500 was resilient, largely flat over the month after rebounding in recent weeks but the European Stoxx 600 was down over 1.5% in the same period. Asian equities were hit hard due to their large trade exposures as China’s CSI 300 Index was down over 10%. Other emerging market equities followed, with falls exacerbated by a stronger US Dollar.
US 10-year bond yields fell on risk-off sentiment to 2.85% and Australia’s 10-year bond yield hovers around 2.6%. Commodities fell during the month as investors worry that trade issues will hit global growth.
The Australian Dollar continues to fall to around 73.7 US cents.
Trade tensions continue to dominate headlines as both the US and China have implemented tariffs on US$34 billion of products each. US tariffs primarily targeted the technology and infrastructure equipment sector but left out mobile phones, while China focussed on agricultural products. There is potentially another US$16 billion of imports being hit with tariffs. Whilst tariffs of these amounts are unlikely to dent global growth, the US has threatened further tariffs on US$200 billion to be announced by the end of August and would be more significant. The amount is more than China imports from the US, so China would have to employ other measures if it wants to affect the US in equal measure. Perhaps more importantly, these trade tensions are undermining business confidence and investment which has the potential to impact global growth more significantly.
Domestically, house prices continue to trend lower as banks hiked mortgages out of cycle due to rising funding costs from overseas sources. Despite this, consumer sentiment and retail sales rose, showing that consumers remain resilient as long as the fall in house prices remains moderate.
Activity indicators continue to support robust US growth, while the number of people employed rose more than expected but the unemployment rate rose by 0.2% to 4% as more people joined the workforce. Core inflation also came in at 2.3% for the last 12 months, above the Federal Reserve’s long term target of 2%.
Like the US, European activity indicators also continue to show growth, and employment figures remain good, with the latest unemployment rate showing a 0.1% improvement to 8.4%. Chinese activity indicators also continue to be resilient in the face of the trade tensions but it is still too early to see the impact flow through.
Up next is earnings season around the world. Strong earnings growth is expected, especially in the energy sector, and tax cuts in the US will provide an extra boost with S&P 500 earnings growth forecasted to be a whopping 20.5%. Domestically, the lower Australian Dollar will be a boon for many companies.
The implications of a trade war
The US and China have now officially levied tariffs on imported goods from each other. Coupled with the steel and aluminium tariffs that the US has implemented across the world, including traditional allies like Canada and Europe, the world is at risk of an escalating trade war that could hit economic growth and consumers. Protectionism has historically hurt economies more than helping them, despite protectionist tariffs generally being implemented to help prop up growth in targeted sectors in the first place. This is due to the reallocation of resources from more efficient sectors to less efficient ones.
Whilst the current tariffs represent a very small portion of global GDP and is unlikely to directly derail growth, it is the indirect implications that will hurt the most. Current estimates for direct impact are around 0.3% and will remain below 1% even if the US escalates tariffs on Chinese imports. With the US economy estimated to grow around 3% this year and over 2% next year, a recession should be avoided. However, the issue with tariffs is that they are not contained and will flow on to the consumers and businesses, not just within the sectors that have been targeted.
The steel and aluminium tariffs mean that consumers or businesses, or both, will likely have to pay higher prices for anything made with steel or aluminium. This ranges from drink cans to planes and buildings although tariffs are not directly levied on these products. Therefore, this will serve to drive up inflation, potentially forcing the central banks to raise interest rates to contain price increases, draining liquidity from the market. In the current world where debt levels are high and savings rates remain low, a credit crisis could arise if liquidity dissipates too quickly.
Business and consumer confidence are also important cogs in the economy that could be knocked out of place by tariffs. The uncertainty around future tariffs or the overall implications of tariffs could delay spending and investment. Delaying spending and investment has a direct short-term effect on economic growth, for example, developers delay building up a new area or companies push back hiring plans. There would also be a longer-term impact on potential growth rates if investment plans are delayed.
These flow-on effects are much harder to define and estimate, but there is a common consensus that the direct impact of tariffs severely understate the overall impact on economic growth. Thus far, the latest readings of consumer and business confidence have generally remained robust but some indicators have shown signs of negativity seeping through. It is still early days and there is room for negotiations and reversals of these tariffs, but investors should watch confidence and sentiment readings closely for signs of cracks. Asian equities and bonds have already sold off heavily in the past few months but US and Australian markets have remained resilient. This could change if confidence takes a hit. Conversely, if the US mends trade relations with the rest of the world, the Asian market whose economies rely heavily on trade will likely see investors flock back.
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