Economic Update - April 2015
Outlook for Investment Markets
The global economy in aggregate is ticking along, with positive
economic growth against a backdrop of very benign inflation and
very accommodative policy settings. The growth, though, is quite
varied across the globe – the U.S. has been leading and China has
been slowing down – and the fall in the oil price has been positive,
with a lot of the resulting dividend still to work through over the
next year. That's given central banks the latitude to cut interest
rates, including in Australia. Locally, not a lot has changed, with the
Australian economy still growing more slowly than usual. What is of
concern is that valuations across many asset classes are high and
emphasise the growing risk to the downside.
Key points across the Asset Classes
Australian Cash and Fixed Interest
• Short term interest rates continue to drop, falling to 2.21%,
down from 2.78% at the end of 2014. This reflects the
0.25% cut in official interest rates by the RBA in February.
• Local bond yields have closely tracked the U.S bond
market, with the yield back down to 2.32% at the end of the
quarter.
• The Aussie dollar was down 6.9% in the March quarter (to
US76.3¢ from US82.0¢).
Australian Equities
The Aussie dollar narrowly
averted the fate of being worth
less than the New Zealand
dollar after the Reserve Bank
of Australia unexpectedly left
the cash rate unchanged in
April.
Australian Cash & Fixed Interest – Review
Short-term interest rates have dropped this year: the 90-day
bank bill rate is down from 2.78% at the end of 2014 to 2.21%,
reflecting the actuality of a 0.25% cut in official interest rates by the
Reserve Bank of Australia on 3 February and the financial markets'
anticipation of a further 0.25% cut in the near future. Local bond
yields have closely tracked the U.S. bond market, dropping in
January and early February (the 10-year Commonwealth bond yield
hit a low of 2.28% on 3 February), rising in the rest of February and
early March (the 10-year yield got up to 2.74% on 9 March) before
dropping more recently, with the yield back down to 2.32% at the
end of the quarter.
In terms of its headline rate against the US$, the Aussie dollar was
down 6.9% during the March quarter (to US76.3¢ from US82.0¢),
but the headline result somewhat overstates the decline in the
overall trade-weighted value of the A$. The trade-weighted index
was down 4.8% as weakness against the US$ and the yen ( 3.8%)
pulled the Aussie down, but strength against the euro (+4.8%)
partly offset the dollar and yen moves. The Aussie dollar narrowly
averted the fate of being worth less than the New Zealand dollar
after the Reserve Bank of Australia unexpectedly left the cash rate
unchanged in April. At the time of writing, the A$ was trading at a
little above parity at NZ$1.017.
1 | Economic Update - April 2015
• Local share market had a strong March quarter with the
S&P/ASX 200 index providing an 8.9% capital gain and a
10.3% total return including the value of the dividend yield.
• Materials have weakened significantly, particularly as iron ore
prices fell.
• Across the sectors for the quarter; consumer discretionary
up 12.7%, financials rose 12.4%, industrials increased
8.0%, IT stocks gained 5.7% and consumer staples lagged,
rising 2.0%. Mining increased 4.0% for the quarter, but was
up 15% up until early March.
Australian Property
• Australian Property had a good March quarter, with a capital
gain of 8.4%, and a total return including dividend income
of 9.4%.
International Equities
• The MSCI World index, measured in the local currency of
each overseas market, was up 4.4% for the March quarter,
however it is only up 1.8% in US$ terms given the strength
of the US$.
• Given the 6.9% decline in the Aussie dollar against the
US$, the MSCI World Index has produced a gain of 9.3% in
Aussie dollar terms.
• Euro-zone shares have risen strongly, with the
FTSEEurofirst300 index up 15.8% for the quarter, given the
introduction of QE packages.
• Across the developed nations, the German DAX rose 22%
the French CAC rose 17.8%, and the Japanese Nikkei
rose 10.1%. This is in contrast to the countries that didn’t
introduce new QE initiatives, where the FTSE100 in the UK
rose 3.2% and the S&P500 in the US up only 0.4%.
• Markets within the BRIC economies all traded higher for
the quarter, just at differing levels. Brazil’s Bovespa index up
2.3%, FTSE Russia index was up 9.9%, India's Sensex up
1.7%, and China’s Shanghai Composite index up 15.9% for
the quarter.
Economic Update - April 2015
Australian Equities – Review
The share market had a strong March quarter, with the S&P/ASX
200 index providing an 8.9% capital gain and a 10.3% total return
including the value of the dividend yield. Financials was one of the
stronger sectors, up 12.4%, and consumer discretionary shares also
did well (+12.7%). Industrials were up 8.0% and IT stocks up 5.7%,
while consumer staples lagged with a rise of 2.0%. The 4.0% gain
for the S&P/ASX 300 mining shares, while formally true, is not a very
helpful guide to the reality. Resource stocks had been doing well up
to early March, at which point they had risen 15% from the end of
2014 but more recently had weakened significantly, particularly as
iron ore prices fell.
Emerging markets show the same picture of a quarter that looks
good on paper (+4.6% in local currencies, +1.9% in US$) but which
again needs to be seen in longer context: the MSCI Emerging
Markets index at the end of March was also little different to its levels
nine months earlier. Eastern Europe was the strongest performer,
with its MSCI index up 11.5% helped by a turnaround in the fortunes
of the previously devastated Russian market – the FTSE Russia
index was up 9.9% for the quarter. China's share market was also
strong, with the Shanghai Composite index up 15.9%, although
the rise looks distinctly speculative and liquidity driven, not linked to
any likely improvement in Chinese corporate profitability. The other
two members of the BRIC group of leading emerging markets were
quieter, with Brazil's Bovespa index up 2.3% and India's Sensex up 1.7%.
Australian Property – Review
Australian Cash & Fixed Interest – Outlook
Like the wider equity market, A-REITs had a good March quarter,
with the sector providing a capital gain of 8.4% and a total return
including dividend income of 9.4%.
There is a strong expectation in the financial futures market that the
RBA will cut rates again in the next few months, with the 90-day
bank bill yield tipped to dip below 2% by September and stay there
over the following year on current pricing. The latest RBA decision,
on 7 April also left the door open: "Further easing of policy may be
appropriate over the period ahead." Even so, the cash rate may not
come down as quickly as many pundits in the press expect. Growth
may be slow but it is still 2% or a slightly higher, a growth rate a lot
of countries would wish for, so there is no pressure on the RBA and
it may prefer to keep its firepower. Even if the RBA does not cut in
the next month or two, the rates offered by the banks may still fall.
Banks have been cutting deposit rates faster than the cash rate has
been falling. The RBA's data on banks' “specials” shows the average
special in December 14 was 3.3% and by March had dropped to 2.7%.
International Equities – Review
For the March quarter, and measured in the local currency of each
overseas market, the MSCI World index is up 4.4%, which at first
glance looks like a solid advance. But another way of looking at it
is that world shares have struggled to make much headway over
the past nine months, with setbacks (notably in September and
October of last year) cancelling out the better periods. At the time of
writing, the MSCI World index was almost exactly where it was at the
beginning of July last year.
Currency movements have also been important. While the MSCI
World is up 4.4% in local currencies for the March quarter, it is up
only 1.8% in US$ as a result of the strength of the US$. Fortunately
for Australian investors, this return has been amplified by the Aussie
dollar's 6.9% decline against the US$, producing a 9.3% gain in
Aussie dollar terms.
By region, the strongest developed market performance has
come from the two areas in which QE monetary policy stimulus
has been let rip. Euro-zone shares have risen strongly, with the
FTSEurofirst300 index up 15.8% for the quarter, though it needs
to be remembered that gains in euro terms are less than they look
because of the weak euro: the A$ rose by 4.8% against the euro
during the quarter, reducing the gain to 10.5% in A$ terms. Both
Germany (DAX +22%) and France (CAC +17.8%) delivered sizable
gains. And Japan also had a good quarter, with the Nikkei index up
10.1%. Currency moves again came into play, but in a good way,
with the return boosted by the A$'s 6.4% decline against the yen. In
contrast, the major economies that have not taken new QE initiatives
have made smaller gains, with the FTSE100 in the UK up 3.2% and
the S&P 500 in the U.S. up only 0.4%.
2 | Economic Update - April 2015
Their recent moves in close formation with U.S. bond yields have
shown that local bond yields are likely to follow U.S. bond yields
upwards over the rest of this year. The current consensus economic
forecast in the U.S. is that the U.S. 10-year bond yield will rise by
about 0.5% during the rest of the year but against a backdrop of a
relatively sluggish local economy it is likely that the local rise will not
be quite as large. The long maturity bonds will be affected by the
U.S. but the shorter to medium end is likely to be more supported by
the challenging local economic environment.
There are mixed views on the A$, with some economists thinking the
recent decline in the currency had done most or all that was needed
to bring the dollar down to a sustainable competitive level. However,
others feel further depreciation is likely, and the RBA agrees. It says
in its latest policy statement that "further depreciation seems likely,
particularly given the significant declines in key commodity prices".
Economic Update - April 2015
Australian Equities – Outlook
International Equities – Outlook
There’s little sign that an improvement in economic conditions is
near enough, or strong enough, to warrant increasing exposure to
Australian shares.
The overall global economic outlook is one of ongoing modest
growth supported by vigorously expansionary monetary policy but
the regional distribution of growth is patchy and the high valuations
of growth assets are a concern.
At the moment, the expectation is for single-digit growth in profits
this year and an improvement on that in the future. The Reserve
Bank of Australia is forecasting a quite elongated period of subpar growth, making that point again at its 7 April policy meeting. It
concluded that "growth is continuing at a below-trend pace, with
overall domestic demand growth quite weak as business capital
expenditure falls…The economy is likely to be operating with a
degree of spare capacity for some time yet."
It helps to think of Australian equities as falling into three broad
categories. There are the commodities, where it is on balance,
negative, given export volumes are up and the currency is down but
world prices have also been falling. Then there are the financials,
which are benefitting from being leveraged to the interest rate
cycle. And then there are the others, which are a bit harder to
generalise about but where it is tough to see the case for a sharp
rise in corporate profits. There is also a view that the recent rise in
Australian share prices had less to do with an improving domestic
profit outlook and rather more to do with investors and their ongoing
global hunt for yield.
Australian Property – Outlook
While the operating performance of property has been reasonable
enough in a slow-growing economy (prices are now up 27.9% on
a year ago) – the IPD/Property Council of Australia index shows
property produced an income of 7.1% in 2014 and a capital gain of
3.4%, with all sub-sectors sharing in the gains – and there has also
been some M&A activity that has supported prices, yields have been
forced down and prices boosted by the global hunt for sources of
income. The yield on the sector is in the low fives compared with the
high fours you can get from shares generally.
Investors are shifting the focus of their equity investments from
the U.S. to other markets. Up to this year, it had been an obvious
investment destination as its recovery was ahead of many of the
other developed economies and for a long time the prospects for
corporate profitability looked better there than elsewhere. Now,
however, a variety of issues – the prospect of higher U.S. interest
rates, the potential for faster wage rises, the stronger US$ – were
creating some challenges and as a result, U.S. shares had barely
risen in the March quarter at a time when many other equity markets
were rising strongly.
Rebalancing towards areas in which valuations were lower and the
economic cycle younger, however, is easier said than done as eurozone monetary policy in particular has given a further twist to the
weight of liquidity inflating global asset valuations. While the general
inclination is to look towards Europe and Asian emerging markets
because of their exposure to growth in the developed world, any
open windows of valuation opportunity are closing quickly as the
recent sharp rises in European share prices has shown.
The generally expensive equity markets are now also more
vulnerable to financial or political shocks. It's possible that Chinese
growth could be the slowest since the 1990s and possibly slower
than anyone has been estimating – possibly within the 4.5% to 5%
range. And it's possible that markets are beginning to adjust to that,
as we've seen with the recent price falls for bulk commodities. Other
possibilities include economic or political instability in the countries
most affected by lower oil prices (notably Russia and Venezuela) or
further escalation of tensions in the Middle East. There is a view that
investors are paying too little attention to the sorts of risks that had
caused a slump in world equity prices in the second half of last year,
when Ebola and potentially slower global growth had emerged as
reality checks on equity valuations.
Performance periods refer to the period ending 31 March 2015.
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3 | Economic Update - April 2015