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Market update: Spring 2017

Market update Spring 2017

ClearView investment analyst Jessica Schlosser looks at what happened in global markets in the June quarter and considers the outlook for Australian shares.

Global markets felt the impact of political uncertainty in the June quarter. In Europe, the election of French president Emmanuel Macron and the strong performance of Angela Merkel’s Christian Democratic Union in German elections helped ease concerns of a spreading populist antiglobalisation movement.

During the quarter, the MSCI Europe Index rose 7.4 per cent, supported by subsiding political risk, improved corporate earnings and a stronger economic backdrop.

Brazil’s economic recovery also hit a road bump with the country’s long running political corruption scandal embroiling President Temer.

In Asia, North Korea’s nuclear missile program continued to cause tension although it’s not expected to affect equity markets as long as the US and China continue to cooperate on the matter. While the Chinese share market rose 6 per cent in the quarter, China is increasingly conscious of its financial fragility due to the country’s high corporate debt and the government’s links to their corrupt shadow banking system.

In the United States, Congress’ inability to make meaning fiscal changes – demonstrated by its decision to push big infrastructure spending and tax reform out to 2018 – has led to support for the Trump administration declining. While the chance of a US stock market crash is minimal, US equities remained overvalued as at June 30, 2017 and face a potential correction.

Outlook for Australian shares

Fortunately, Australia hasn’t been affected by the global political uncertainty surrounding the Brexit fallout. However, questions about the direction of the Australian economy are emerging. The minor iron ore rally in the second half of the 2016 calendar year helped push the domestic share market higher but iron ore prices have since come down due to growing stockpiles in China. Furthermore, domestic construction activity is beginning to slow.

Weak wage growth continues to be a concern, especially given the increasing cost of essential services like electricity and gas. This, combined with rising interest rates and tighter credit conditions, leaves Australians at risk of a credit and cash flow crunch.

Still, Australia has an extremely resilient economy. It has recorded 103 consecutive quarters without a recession. Australia now holds the record for the longest run of uninterrupted growth in the developed world, according to the Australian Bureau of Statistics.

The economy’s adjustment to the end of the mining boom in 2013 is largely attributable to a weaker Australian dollar which supports exports and tourism, and makes Australia a more attractive destination for foreign students. New South Wales and Victoria have picked up some of the slack by increasing investment in non-mining industries by 10 per cent annually, while immigration has contributed to population growth and consumer demand.

That said, the Australian government and Reserve Bank of Australia appear to be running out of options to boost the economy. They managed to avoid the GFC by introducing various stimulus packages but these packages cost the government dearly and that burden is still evident. Further stimulus in the event of a downturn is unlikely. On top of that, taking the cash rate below 1.5 per cent will have minimal impact, evidenced by the impact in Europe which has had negative rates for some time.

While the Australian economy may be able to stave off a correction with continued immigration and expansion of non-mining industries, there are concerns it may be a case of delaying the inevitable.

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Market update: Winter 2017

Market update - Winter 2017

Overview

Most share markets experienced strong performance over the March quarter. Investors remain positive about prospects for stronger global economic growth, particularly in the US. Fixed interest markets by contrast have experienced fairly subdued returns. We see the outlook as being balanced between a continued positive economic picture, and the risks of more increases in interest rates in the US. Rising interest rates have, at times in the past, led to some instability in share markets. Accordingly, we continue to believe that maintaining a balanced approach with a diverse mix of investments remains appropriate. That is, some investments that will do well under the positive scenario; and others that will help to mitigate risks should rising interest rates lead to rising volatility.

International shares

President Trump has been well received by the share market in the United States. The market has priced in expectations that tax cuts (now probably delayed until 2018) will boost both the economy and company profits. Emerging markets, which are the share markets in less developed economies, have also experienced very strong performances as fears of trade protectionism have faded.

Australian shares

In Australia, the share market continues to do well. There are warning signs emerging that banks may start to experience a few headwinds, as concerns grow about expensive and overvalued residential property markets. It’s clear that the regulators are signalling to the banks that a more considered and cautious approach to mortgage lending is appropriate in this environment. In time this will probably mean slower lending growth however, the banks have been able to counter this by boosting their profits through raising the interest rates they charge, particularly on investor loans.

Bonds and cash

In Australia, the RBA held rates at 1.5%. In the statement accompanying the decision the central bank took a balanced view towards the outlook. A few concerns were expressed about both the economy and the frothy nature of the residential property market. Balancing this the RBA noted that a stronger global economy was a positive. We think the RBA is on hold for the foreseeable future, and would expect cash rates to be fairly stable in the coming months.

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Market update: Autumn 2017

Market update - Autumn 2017

Cash

The Reserve Bank of Australia (RBA) left the overnight cash rate at 1.5% at its final meeting for 2016 in December and did the same in the February 2017 meeting. Market expectations are that the RBA continues to sit pat throughout 2017.

Bonds

A sharp move in bond yields in November was moderated in December.

2016 was remarkable as yields defied expectations and continued to get even lower in the first half of the year. The Australian 10 year government bond got to a low of 1.8% in early August, before rocketing to 2.9% just before Christmas, primarily on the back of the US market.

The US 10 year hit a low of 1.4% in early August and then climbed to a year high of 2.6% in mid-December. Having said this, the spread (that is the extra yield investors demand to hold Australian bonds over US bonds) continued to tighten, reflecting the contrast between Australia’s post-mining boom economy and a US economy at full employment with the prospect of pro cyclical fiscal stimulus.

Australian equities

Australian equities jumped by over 4% in December, giving a healthy 11.6% return for 2016. As well as the general revival of Keynesian “animal spirits”, Australian shares were driven by developments in China, where authorities, spooked by a sharp slowdown in growth, hit the stimulus lever in late 2015. This revived infrastructure and residential property construction in 2016, which flowed on to our commodity exports.

In addition, an environmentally driven clampdown on domestic coal producers saw the two coals (coking and thermal) rally. Much of the extreme move in iron ore prices, (from USD39.51 a tonne USD 83.58), cannot be explained by fundamentals. Indeed, iron ore stockpiles in China by year end were back to 2014 levels and new supply sources are coming online in Australia, which will add to seaborne iron ore supply in the first half of 2017.

International shares

Developed market equities continued their push upwards, adding another 4.5% in December. The US dollar continued to strengthen against the Australian dollar and even moreso against other currencies due to the elevated price of hard commodities, resulting in currency hedged international shares underperforming unhedged. Emerging markets stocks recovered over the December quarter, following the initial post Trump sell off on fears of protectionism and rising US interest rates. Brazilian shares gave up -3% in December, but still remained one of the best performing markets globally for the year with 37% in local currency terms and an eye watering 67% in USD.

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Market update: Summer 2016

Market update: Summer 2016

Cash

Cash rates have stabilised at low levels. The RBA has lowered overall cash rates in order to support the post mining boom adjustment of the Australian economy. The RBA has cut the target cash rate twice this year by 0.25%, in May and then in August, bringing it to a new historical low of 1.5%. The RBA then left the rate unchanged at its September and October meetings. The market is expecting the RBA to continue to sit pat over the coming months with another cut possible later in 2017.

Bonds

Bonds did well in the first half of this year as investors fretted about a slowing Chinese economy overwhelming the tepid recoveries in Europe and the US; and dragging the world into recession. With the help of Chinese fiscal and monetary stimulus these fears receded and the demand for safe haven assets like government bonds lessened.

Meanwhile the US economy continued to move towards full employment, causing increased speculation that the US central bank would begin to raise interest rates. These two factors saw very low bond yields around the world creep up slightly recently and the bond rally flatten out over recent months. However, returns over a longer time periods still look very respectable for a defensive asset class.

Australian equities

Chinese stimulus has led to a lift in construction activity and a resulting increased demand for commodities like iron ore. This has helped the mining company heavy Australian share market to outdo international shares over the 12 months to the end of September.

International shares

The rebound in commodity markets has driven an appreciation of the Australian dollar this year. This has meant currency hedged international shares investors have done better than unhedged. Infrastructure and property stocks experienced a mild correction over the September quarter. With central banks around the world pushing bond yields to extreme lows investors have sought out alternatives.

Defensive high dividend stocks like infrastructure and property are prime examples of these “bond proxies”. With some of the heat coming out of the bond rally over the September quarter, the bond proxies also gave up some ground. Emerging markets were the best performing asset class over the September quarter, with compelling valuations attracting interest.

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Market update: Spring 2016

Market update - Spring 2016

Cash

Cash rates keep falling in Australia, with another interest rate cut in May. It seems likely that this will not be the last rate cut with the RBA widely expected to cut again possibly in August.

Bonds

Fixed interest markets recorded strong returns for the year. The economic environment remains supportive of bonds, with modest levels of economic growth and low inflation. Fixed interest yields around the world are very low, in some cases negative, and it would seem likely that future returns will be more muted.

Australian shares

Australian shares end the financial year fairly flat but certainly experienced some volatility over the prior 12 months. A strong rally in the last quarter helped Australian shares recover after the falls experienced in the first few months of the year.

For the full year market returns have been fairly flat.

Valuations in the share market are not overly demanding, but the economy and share market face some headwinds from a slowdown in the Chinese economy, Australia’s largest trading partner.

International shares

International shares end the financial fairly flat but certainly experienced some volatility over the prior 12 months. A strong rally in the last quarter helped international shares recover up after the falls experienced in the first few months of the year. The US share market was one of the better performers,

European and some Asian share markets experienced negative returns. Emerging markets struggled but look very attractively valued.

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Market update: Winter 2016

Market update: Winter 2016

Cash

The RBA has had interest rates on hold for an extended period and the recent appreciation of the Australian dollar will put some pressure on the RBA to further cut interest rates. The fall in our currency from around $1.10 US dollars to down in the sixty cents range helps our exporters and aids the post mining boom rebalancing of the economy to other sectors like manufacturing.

The recent rebound in the Australian dollar towards 80 US cents has hurt our exporters. If the RBA was to lower interest rates, parking cash in Australian dollars becomes relatively less attractive for foreigners and the reduced demand can cause it to move downwards.

Australian bonds

The fear of January drove investors to flee equities and seek out safe havens like Australian Government Bonds. This meant Australian bonds did well over January and into February. The turning of sentiment into March has seen some of this mini rally in bonds come off and the asset class had a small negative return over the month. However, bond investors have still seen a solid positive return over the year to date.

International bonds

International bonds have had a stellar first quarter this year. The heightened volatility in markets has reminded investors of the importance of bonds as effective portfolio diversifiers. High quality government bonds will tend to appreciate in price when stocks are falling.

Later in the quarter, central banks provided some impetus for bonds to rally. The European Central Bank and Bank of Japan made additional commitments to their bond buying programs. The US Federal Reserve indicated that there would be less interest rate rises this year than previously predicted. Prices of bonds move in the opposite direction to yields. Consequently, bond investors enjoyed a capital gain as yields ground ever lower.

Australian equities

Australian shares bounced back hard in March. Those sectors that had been punished the most in January benefited the most in the subsequent whipsaw rally. For example, the S&P/ASX Metals and Mining sub index lost 10% in January then put on 11% in February and 7% in March to end the quarter up a net 6%. More defensive sectors, such as healthcare, didn’t do as well. The Healthcare sub index ended the quarter in the red, losing 2%.

International shares

Those markets and sectors beaten up the most in January and the first half of February have rallied the hardest. For example, Chinese companies listed in Hong Kong fell 15% in January alone. In March they rallied 14%. The Australian dollar has appreciated over the quarter and so currency hedged international shares have outperformed unhedged.

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Monthly market review: February 2016

Monthly market review - February 2016

How the different asset classes have fared

(as at end February 2016)

Table - February 2016

Cash

The RBA left the official cash rate on hold at 2% for the 9th successive time at its 2nd of March meeting. The central bank last took action with 0.5% worth of cuts in the first half of last year.

The statement accompanying the decision made reference to the measures taken by APRA to dampen down property lending, particularly for investment properties. Frothy property prices, particularly in Sydney and to a lesser extent Melbourne, has been one factor staying the RBA’s hand from cutting interest rates further. This may now be less of a restraint, allowing the RBA to loosen monetary policy further in order to support the post mining boom rebalancing of the economy should this become necessary.

Bonds

Bonds benefited from the continued risk adverse sentiment in February. This was despite many government bonds around the world (but not in Australia) sporting negative yields. That is investors are, in effect, paying governments for the privilege of lending to them. Bond investors seem more interested in return of their capital than the return on their capital. Expectations of deflation are also a factor; meaning while the nominal return is negative the real return could still be positive if prices fell further than the negative yield. In a world of negative interest rates the 2.5% yield on the 10 year Australian Government Bond doesn’t look too bad.

Australian equities

Although Australian shares finished in the red in February, there was a meaningful rebound in the second half of the month. At mid-month the All Ordinaries index was down by over 5%. Some recovery in sentiment globally saw investors, who sensed the New Year sell-off as overdone, stepping in and driving the market up. This provided some relief for shareholders of resource stocks, with the ASX 200 Materials sub index putting on 7.6% over the month.

International shares

The sharp falls that have characterised 2016 so far gave way to a bounce from mid-February that ameliorated some of the losses.

A recovery in the oil price, along with other commodities, was one factor in the improvement in sentiment.

US economic data later in February was also mostly positive helping to ease concerns that the world’s largest economy was tipping into recession.

Finally, concerns that central banks were out of ammunition eased. With the Bank of Japan and the European Central Bank still firmly in easing mode and the market pricing in little chance of the US Federal Reserve further increasing interest rates, markets seemed to believe stimulatory monetary policy would continue to back stop share markets.

 

 

1Bloomberg AusBond Bank 0+Y TR AUD, 2Bloomberg AusBond Composite 0+Y TR AUD, 3JPM GBI Global Ex Australia TR Hdg AUD, 4S&P/ASX All Ordinaries TR, 5MSCI World Ex Australia NR AUD, 6Vanguard Intl Shares Index Hdg AUD TR, 7MSCI EM NR AUD, 8S&P Global Infrastructure NR AUD, 9S&P/ASX 300 AREIT TR, 10FTSE EPRA/NAREIT Global REITs NR AUD

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Market update: Autumn 2016

Market update - Autumn 2016

Cash and bonds

As widely anticipated, the US Federal Reserve finally moved off zero and increased cash interest rates by 0.25% in its last meeting of 2015 held just before Christmas.

A number of market commentators now view this as a mistake with no signs of inflationary pressures, financial market dislocation and data showing the US economy barely grew at all in the last quarter of 2015, all suggesting a rate rise wasn’t warranted.

While we are probably unlikely to see the Fed doing a complete backflip and cutting rates; it seems likely the pace of monetary policy tightening will be very gradual.

In Australia, the RBA sat pat for the 7th meeting in a row in December leaving the cash rate at 2%. With the ebbing of the mining boom a decent case can be made for the central bank to cut rates further in order to aid the difficult rebalancing to other sectors of the economy.

However, the RBA does not want to push residential property prices (particularly in Sydney) even higher and so has found its hands tied. Last year, non interest rate tools were introduced in order to dampen down some of the more speculative elements of the housing market. The effect of these “macro-prudential” policies has been the banks have increased interest rates on loans to investors in residential property. This in turn is now showing up in property price data, with prices flattening out over the last few months. It would seem then, that the RBA’s hands are no longer tied and we wouldn’t be surprised to see rate cuts in 2016.

Australian equities

This less than stellar performance of Australian shares reflects the fate of commodities generally as falling Chinese demand met increasing global supply. With mining and energy stocks making up a good proportion of the ASX the end result isn’t too surprising. Both the resources and energy sub-sectors of the ASX 200 lost a quarter of their value over 2015.

Other sectors had a happier 2015 and ensured the past year wasn’t a complete washout for Australian shares. Utilities were the top performing sector returning 23%. Consumer discretionary (18%), industrials (16%) and healthcare (16%) also did well.

International equities

The depreciating Australian dollar ensured currency unhedged international equities outperformed hedged last year. While it was a lot easier call to make when the Australian dollar was north of $1.10 US dollars, we think the Australian dollar still has room to fall a bit further as the Australian economy continues to negotiate the difficult transition forced upon it by the end of the mining boom.

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Market update: Summer 2015

Market update: Summer 2015

Cash

There have been a series of small increases in some lending rates for housing, as banks seek to bolster their capital following recent changes in capital requirements. This is good for the banks, the additional capital makes them more secure, but it is being paid for by consumers. The Reserve Bank of Australia (RBA) remains on hold with official cash rates remaining steady at a historical low of 2.0%. The question of whether the RBA will cut rates further remains open. With no sign of inflation picking up, and early indications that housing prices are softening, there is scope for further rate cuts.

Bonds

Australian bonds are likely to be caught between two competing forces, the slowing Australian economy should be positive for bonds; while the prospect for rate rises in the US could see bonds under pressure. How this balancing act plays out remains to be seen. Our best guess at this stage is that the former is the preeminent influence and that bonds appreciate modestly in price as the local economy slows.

Australian equities

The Australian share market sold off again in September, following on from the falls in August. Subsequently, October saw some recovery.

The resources sector continues to be out of favour even though the two big miners BHP and RIO hold world class assets and are the lowest cost producers of iron ore in the world. The banks and healthcare companies are clearly the market favourites. We have some concern that the amount of leverage inherent in the banks may pose some problems should a slowdown in China and the local economy lead to bad debts rising, and house prices falling. Healthcare companies look attractive in terms of industry dynamics, but are expensive relative to their own history.

International equities

The quarter ending September was not a good one for shares. It was also not a good one for the Australian dollar, but the depreciating currency provided some buffer from share price falls for currency unhedged investors in international shares.

As with the Australian share market, international markets rebounded in October. Emerging markets continue to look attractive from a valuation perspective, while US shares seem somewhat overvalued.

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Market update: Spring 2015

Market update - Spring 2015

Cash

The Reserve Bank of Australia (RBA) cut the official interest rate over the past quarter to a historical low of 2.0%. If economic and financial conditions deteriorate in the coming months the RBA may make further cuts to stimulate economic growth, although market expectations are that rates will remain unchanged for sometime.

Australian and international bonds

Australian and international bond yields have risen in recent months primarily due to the market unrealistically pushing yields down to levels that did not adequately reflect the risks. The rising yields have resulted in bond values falling, as bond yields and price move in opposite directions.

Australian equities

The Australian share market has had a good run and now seems to be taking a breather. With expectations that economic growth will remain fairly subdued into 2016, it is unlikely that company earning growth will be strong for sometime. Therefore whilst the recent falls in the market have made valuations more attractive, investors will continue to need to be selective.

International equities

In recent weeks, developed equity markets have become more volatile in response to the Greek debt crisis and valuations in some markets that already appeared stretched (particularly in the US market). However we remain confident that opportunities remain, particularly in non-US markets including Europe and Japan, where valuations are not as extended.

Furthermore for Australian investors the prospect of further depreciation in the Australian dollar means unhedged international equities are likely to continue to see a boost to returns.

Emerging markets

In the past few weeks, we have witness a dramatic fall in one class of shares in the Chinese share market. This class of shares is largely open to, and traded by, Chinese retail investors, and therefore has little direct impact on Australian investors. We continue to find selective opportunities exist in these markets, especially given valuations remain cheap when compared to share markets in the developed world.

Infrastructure

Listed infrastructure has followed many equity markets down in recent months but has delivered solid returns over the past year. The fundamentals of this sector-solid predictable companies with cash generative business models make it a preferred investment option for those investors with a longer term investment horizon.

Listed property

This sector has been one of the strongest performers over the last year. In more recent months performance has slipped a little. The sector remains underpinned by solid asset backing.

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Market update: Winter 2015

Market Update Winter 2015

Cash

Following the Reserve Bank of Australia (RBA) decision to cut the official interest rate to 2.25% in February, they did so again in May to a record low of 2%. Financial markets, however, are expecting additional rate cuts in the coming months. The only question appears to be how far the RBA will cut further in this cycle, given the current rate is at a historical low.

Australian and international bonds

Australian bonds delivered strong returns in the past 3 months. With interest rates currently at very low levels, it would seem likely that future returns to this sector will be lower. A weak Australian economy would be the best environment for further gains in bonds. A strong US recovery by contrast would probably see bonds struggle.

Australian equities

The Australian equity market performed strongly in January and February this year as interest rates were cut. However the market has drifted throughout March and closed a little lower by the end of the month. With Australian corporate earnings and profitability remaining subdued, valuations are becoming less attractive.

International equities

Developed equity markets performed strongly early in the year supported by US economic strength, lower oil prices and continued central bank stimulus. However, the recent rise in prices has resulted in a further ratcheting up of already stretched valuations, especially in the US. We therefore believe that greater opportunities exist in non US developed markets particularly in Europe and Japan.

Furthermore, for Australian investors the prospect of further depreciation in the Australian dollar means unhedged international equities are likely to continue to see a boost to returns.

Emerging markets

Overall the valuations in emerging market (EM) equities look cheap when compared to share markets in the developed world. Emerging markets can no longer be treated as a monolithic block in our view. There are good reasons why some EMs appear cheap, with some economies facing significant challenges. Others, in contrast, appear to offer some good opportunities.

Infrastructure

Listed infrastructure did well over the quarter and has outperformed the broader market over the full year. Investors have sought out these solid predictable companies with cash generative business models.

Listed property

Property topped the performance tables for the quarter, and indeed for the year. The primary driver of this remains the global
search for yield. How much further this can carry the sector, however, is becoming increasingly questionable. The yield-driven demand for the sector may yet carry prices higher but a repeat of this year’s spectacular returns looks unlikely.

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Falling oil prices and the impact on global growth

Falling oil prices and the impact on global growth

There has been significant media attention in recent weeks following a dramatic fall in oil prices. The impact of this fall depends primarily on whether the fall has been due to increasing supply or falling demand.

On this question our research partner, BCA, argues that increasing supply factors; technological advances in shale production and increased supply in some of the OPEC countries has been the primary factor.

Whilst increased supply can have both positive and negative impacts on global growth, the net impact is that it increases global spending. That is, oil consumers tend to react quickly to falling prices by spending more on non-energy goods and services.

The International Monetary Fund (IMF) estimates that the level of global real GDP would rise by 0.5% to 1.3% over a two-year period in response to a supply-induced 20% decline in oil prices, depending on the extent to which lower oil prices boost consumer and business confidence.

So on balance, as long as the lower prices can be sustained, there is likely to be a positive impact on global growth. However we stress that falling oil prices is only one influence on growth and other factors, including central bank action, also play a significant role.

As a result we have not altered our overall view of global growth at this time and thus our model portfolios have not been changed to reflect these developments.

The following chart and diagram illustrate the impact of the falling oil price on both regions and businesses.

Falling oil prices graph

* Information in this article has been drawn from The Bank Credit Analyst, December 2014

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