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.
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.
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.
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.
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.
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.