Australian market subdued

13 Nov 2017

By Shadforth Financial Group

The Australian market continued to lag international markets through the September quarter as the S&P/ASX 200 index struggled to break out of its narrow trading range.

This can be attributed to mixed economic indicators. Business confidence was weaker, falling below its long term average for the first time since mid-2016. This was due to concerns over customer demand, margin pressure and government policy.  Business confidence did lift in September with the construction industry leading the way but the retail sector continues to struggle.

Consumer confidence is also weak and remains in pessimistic territory due to concerns over housing affordability, interest rates and rising energy prices.

More sanctions for North Korea

North Korean missile tests, South Korean bombing drills and North Korea’s war of the words with Donald Trump have increased geopolitical tensions over the last few months. This has prompted a global response in order to tighten the screws on the country.

The UN Security Council has adopted new sanctions on North Korea including limits on oil exports to the nation, a ban on textile imports and the prohibition of work authorisations for North Korean citizens working overseas. China has also   ordered North Korean companies operating within China to close up shop within 120 days, a shift in the close relations the two nations have held since the Korean War (1950-1953). If enforced, the order will have a significant impact on the North Korean economy given that China is its largest trading   partner. However, China’s main priority is still regional stability in order to support the legitimacy of the Chinese Communist Party. War in the region is therefore not an option for China and it remains to be seen whether they will stringently enforce sanctions on North Korea.

Investors have not been deterred by the escalation in geopolitical tensions with North Korea. Markets seem to have grown immune to hydrogen bomb tests and missile launches for example. While North Korea remains a tail risk for financial markets, it’s unlikely that markets will be significantly affected unless the situation evolves into armed conflict.

German federal election

At the outset of 2017, the German federal election was viewed as a key risk to financial markets due to the rise of populist and anti-EU political parties during the last few years. However, Angela Merkel’s centre-right Christian Democratic Union (CDU) party held a commanding lead in the polls from April onward. Financial markets therefore anticipated that Merkel’s CDU party would claim the most seats in the Bundestag (national parliament) and would retain the position of Chancellor of Germany that she has held since 2005. Polls got the call right and as a result the market reaction was muted. However, the process of forming a coalition government will be difficult for Merkel given the decision by the Social Democrats (20 per cent of the vote) to discontinue their ‘grand coalition’ with the Christian Democrats (33 per cent of the vote). Merkel will have to negotiate with the Free Democratic Party and the Green Party in forming a coalition and this may take some time.

The election result did surprise investors in one respect. That is, the election result followed the widespread occurrence over recent years of right wing parties gaining   support thanks to regional voters and those who do not normally vote. Surprisingly, right wing party Alternative for Germany placed third with 13 per cent of the vote which gives it a better platform to expand its support base and agenda. Although Merkel won the election, it came at a cost because her campaign had poorly defined initiatives regarding social security, unemployment and economic welfare. While markets expected Merkel to win the election, they did not expect such strong support for the right wing party which highlights the fact that populist parties have gained supporters and the risk of protectionism has not disappeared.

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