Below are the forecasts made on 1 January 2018 and I have included an assessment of the accurate of those forecasts at the end, in brackets and in bold.
Having registered terrific growth in recent years, a cyclical pull-back in stocks seems to the on the cards during 2018. “Don’t fight the Fed” might prove to be apt again with a near certain continuation of monetary policy tightening from the US Federal Reserve and a wind back in QE. Overlay other policy/political risks from the Trump administration, I would be looking for the S&P500 to fall by 10 per cent or so to around 2,450 (or lower), the Dow down to 21,800 and would kick off the year with a trade to capture that sort of decline. Risk: Further downside [8 out of 10. It was a year where stock prices fell largely as anticipated. That said, the extreme volatility in the final months of 2018 saw the Dow reach a low under 21,800 and the S&P was down about 10 per cent at the recent low. Being short US stocks was a winning trade.]
Australian stocks are inexorably linked to commodity prices and the housing cycle, both of which are erring on the down side. With a probable change in global sentiment towards stocks, the ASX200 is forecast to pull back to 5,750 through the year. So not a bad result, but more likely down than up. Risk: Upside [9.5 out of 10. The ASX fell to a low under 5,500 and was clearly weak during the year, Housing (bank stocks) dominated the weakness even if mining stocks were, for a while, more resilient. The falls were compounded by the RBA holding interest rates at a restrictive level.]
The Australian dollar
I’m bearish the Aussie dollar in part because of domestic economic slumber, but also because of a further erosion of the interest rate gap between Australia and the world, a topping out in commodity prices, politics (2018 is likely to be an election year) and a turn in sentiment towards the US dollar. I’m looking for a break below US0.7000 and to dip on the cross rates, most notably the NZD (to 1.0000) and EUR (0.6200). Risks: Upside [8.5 out of 10. The AUD started 2018 at 0.7800 USD, 1.1050 NZD and 0.6550 EUR. It ended 2018 at 0.7050, 1.0500 and 0.6150 respectively which locked in a great forecast with AUD falls of around 5 to 8 per cent. Being short AUD vs USD, NZD and EUR were profitable trades.]
Monetary policy and bond yields
OK – the big call which is the glue that feeds into other forecasts. It is that the RBA will continue to see ongoing low inflation, weak wages, a notable dip in house prices and it will eventually trim interest rates, perhaps twice, to 1.0 per cent by year end. With rate hikes priced into the next year, the trade is to be long the OIS (or IBs) which is profitable even if there is no cut. An interest rate hike, into a weakening housing market. The year kicks off with 10 year bonds yielding around 2.75 per cent - - the call is for yields to tick a little high in the latter part of the year driven by a bearish US lead, but this will imply Australian 10 years will trade 50 basis points below equivalent US rates. Risks: Downside (for yields) [8 out of 10. Sure, the RBA did not cut interest rates, but the market went from pricing in a full rate cut and then some at the start of the year to pricing in rate cuts. It was hugely profitable to position for rate cuts at the short end of the yield curve. And so it was with 10 year bonds which ended the year at 2.3 per cent and around 45 basis points below US yields.]
A few ups and a few downs but basically annual growth will be in a 2.25 to 2.75 per cent range throughout the year. Any break in GDP growth towards and then above 3 per cent will be difficult with household consumption spending (over 50 per cent of GDP) held back by weak incomes and the housing downturn. The housing downturn will crimp growth in the latter part of the year. The good news will be in the form of what should be a strong upswing in private sector CAPEX, which should growth by 5 per cent and more, solid exports and a sustained level of public sector demand. Risks: Downside via housing [5 out of 10. The economy was generally a touch stronger than forecast with the error being driven largely from the resilience of household consumption. That said, the latest data show annual GDP growth of 2.8 per cent.]
A mediocre economy will see employment growth moderate in 2018, with annual jobs growth cooling to around 1.25 per cent from the break-neck 3 per cent registered in 2017. This will see the unemployment rate remain near 5.5 per cent and the risk is a rise towards 6 per cent in the labour-intensive retail space continues to be pressured by sluggish consumer demand. Annual wages growth will remain near flat, perhaps inching up towards 2.25 per cent, but this will not be sufficient to underscore a material rise in incomes or purchasing power. There are likely to be some reassessments about the level of full employment in the economy with the firm conclusion focussing on a figure well below 5 per cent. Risks: More acute weakness in labour conditions. [6 out of 10. Jobs growth has been materially stronger and the unemployment rate moderately lower than forecast, but the wages forecast was spot on. It is also important to note that the assessment of NAURI has strongly entered the debate, including from the RBA.]
Inflation remains a dead duck – in underlying terms it will be between 1.5 and 2 per cent right through the year with no trend emerging to help guide markets. Global pressures, technology, sub-optimal growth and intense competition at the consumer level will keep a lid on any inflation pressures that might emerge from a sold level for global growth. Risks: Neutral [10 out of 10. Inflation has flat-lined through the past year, around 1.75 per cent. Inflation showed few signs of picking up at any stage in 2018. The drivers were fairly clear at the start of 2018 and remain in place now.]
In May, Treasurer Morrison will announce a $20 billion ‘improvement’ in the budget bottom line over the 4 years of the forward estimates. A lift in commodity prices will account for the bulk of these gains. Accordingly, the 2018-19 budget deficit will be slated to be around $15 billion and as it will likely be the final major economic statement before the election, there is a risk of fiscal largesse in the form of additional government spending (from an already high base) and income tax cuts. Gross government debt will reach a new record around $560 billion by year end. Risks: a wider deficit if the largesse is extreme or the weaker economy hinders revenue. [5 out of 10. There was a sharp narrowing in the budget bottom line which was driven by unexpected strength in commodity prices. There was no 2018 election which meant the fiscal largesse is likely in 2019, not 2018. Gross government debt ended 2018 at $538 billion.]
The tug-o-war between a solid expansion in the global economy and a ramping up of output will likely see some consolidation of commodity prices although the risks remain to the downside given the falling cost of production and possibility of a less robust Chinese economy. Oil should settle near US$50 a barrel while iron ore could ease a little to the mid US$60 a tonne due mainly to supply issues. The RBA index (in USD terms could well end the year little changed from today. Risks: Downside [8.5 out of 10. Oil dipped below US$50 while iron ore settled around US$67 – close to the forecast trends. That said, the RBA index of commodity prices edged up through the year.]
A tightening in lending, buyer fatigue, poor investment returns and a solid supply of new dwellings will keep downward pressure on prices. It looks like the falls in Sydney prices evident since September 2017 will continue into 2018, while Melbourne prices will ease a little. National house prices are forecast to drop by between 5 and 10 per cent. Risks: Neutral [9 out of 10. According to Corelogic data, house prices fell around 6.25 per cent in 2018 with significant falls in Sydney and to a slighter lesser extent, Melbourne.]
All in all, it is a little bit embarrassing to have done so well with the forecasts last year. This will be filed away and let’s hope 2019 delivers results half as good!