As we have flagged in previous editions of the IOR, our expectation has been that markets will be characterised by increasing levels of volatility and subdued growth. This has been the case when we reflect on 2016 so far, which started off with a bang with markets falling on the back of uncertainty surrounding China’s economic prospects and slumping commodities markets. More recently, markets have rebounded after shrugging off early concerns over Brexit and as headwinds in emerging markets faded as US rates hikes have looked less and less likely for this year.
As we have flagged in previous editions of the IOR, our expectation has been that markets will be characterised by increasing levels of volatility and subdued growth. This has been the case when we reflect on 2016 so far, which started off with a bang with markets falling on the back of uncertainty surrounding China’s economic prospects and slumping commodities markets. More recently, markets have rebounded after shrugging off early concerns over Brexit and as headwinds in emerging markets faded as US rates hikes have looked less and less likely for this year.
However, our view on market fundamentals has not materially changed, in that we continue to believe that we are entering a volatile, low return environment, company earnings are generally subdued and valuations on key equity markets remain at fair value or overpriced. Our medium term asset allocation remains defensively positioned preferring cash and alternative assets over equities. We continue to hold a neutral allocation to listed property and infrastructure despite rich valuations, noting that such assets may continue to perform in a low yield environment and in a market where we may see some downward pressure. We continue to monitor market prices and valuations and, should there be earnings support, would be looking to increase our allocation to equities if we saw markets at around the 4800 mark for Australian equities and pull back of 10% to 20% for global equities.
The Australian market enjoyed a post-Brexit rally in July, with the S&P/ASX 200 Index moving up to 5562.36 points, the highest level since August 2015. Returns on Australian equities, as measured by the S&P/ASX 200 Accumulation Index, were a solid 6.29%, with all sectors gaining. The largest gains came from the Consumer Discretionary (8.84%), Consumer Staples (8.52%) and Materials (7.78%) sectors, with upside earnings from Myer and Bluescope, while mining services company Monadelphous has almost doubled in value since February following a three-year slump. The Energy sector managed only a modest gain of 0.15%, although the exception was Whitehaven Coal, which gained 56.74% after announcing record coal production.
Small cap returns, as measured by the S&P/ASX Small Ordinaries Accumulation Index, was 8.57% in July, with small shares remaining the strong outperformers over 12 months, returning 22.29%. Earnings season is upon us, with aggregate EPS for FY 2016 expected to fall by -9.0%, which will mean the second of negative EPS in a row. However, aggregate figures are misleading given the resources sector continues to weigh on the market, and EPS growth ex-resources is a respectable 5.0%.
Global markets have entered a period of calm in July following the June Brexit storm, with a series of global events – including terror attacks in Europe, a failed coup in Turkey, and China’s South Sea intervention – failing to produce any real anxiety in global share markets. Indeed, the CBOE Volatility Index (VIX) hit a two-year low during the month – a remarkable 54% drop from the 24 June spike.
The S&P 500 TG Index returned 1.58% in July, while the FTSE 100 TR Index returned 0.65%, after a month of intense volatility in June both leading up to and following the Brexit referendum. The MSCI Emerging Markets Net TR Index returned 2.90%, with no evidence of Brexit contagion, while the German DAX recovered from its June stumble, gaining 6.79%. In Asian markets, the Nikkei 225 Index gained 6.38% in July, while the Shenzhen CSI 300 Index rose 1.59%.
The first morsels of UK and European data post-Brexit have come in the form of July PMI figures, which have painted a diverging picture. Eurozone service and manufacturing PMIs both indicate expansion, with index values around where they were in June. In contrast, the UK services PMI has fallen from 52.3 to 47.4, while the manufacturing PMI has fallen from 52.1 to 48.2. While only one measure of economic activity, this is certainly not an ideal sign.
Australian bonds returned 0.74% in July, with the Australian 10-year Treasury yield pushing down from 1.98% to 1.87%, after hitting a new record low of 1.82%. Australian government bonds returned 0.78% during the month, while Australian corporate bonds remained hampered by the flight to safety, returning only 0.57%. Globally, government bond yields underwent further compression in July, benefitting from a Brexit induced flight to quality.
Bond markets are also anticipating more accommodative monetary policy from central banks. The US 10-year Treasury yield fell from 1.47% to 1.45%, while the German 10-year Bund rose modestly from -0.13% to -0.12%. The German government issued 10-year Bunds with a zero percent coupon for the first time in history, raising EUR 4.038 billion at a yield of -0.05%. The New York Fed’s William Dudley warned against caution in any funds rate hike, citing “sluggish” GDP growth figures, although no policy tightening in 2016 has been ruled out.
The Japanese 10-year yield came back from an unprecedented low of -0.295% to close the month at -0.195% and rising as market calm returned. Global bonds, as measured by the Barclays Global Aggregate TR Index, returned 0.70% in July (in AUD hedged terms). The return on US corporate investment grade bonds was 1.54% in July, while US high yield debtreturned 2.62% as yields moderated. Credit spreads continued to narrow following a brief Brexit spike, with the Bank of America Merrill Lynch US High Yield Option-Adjusted Spread narrowing from 6.21% to end the month at 5.69%, much reduced from its February high of 8.87%.
The S&P/ASX 200 A-REIT Accumulation Index returned 5.42% in July, with the RBA’s August rate cut likely to drive returns, and expected further easing from central banks is likely to prop up the yield trade for some time yet. Concerns remain about excessive gearing and overpricing in some cases, driven by persistently low interest rates. The RBA has indicated that it believes the housing market will slow, especially as the new supply of apartments impacts the major cities. For now, though, with interest rates low and potentially moving lower, the A-REIT market remains in rude health.
Globally, REITs returned 1.72% in July (in AUD hedged terms), while the FTSE EPRA/NAREIT Developed NR Index gained 4.89%.
In the US, REITs returned 4.20% (in USD terms), with the market under no immediate threat from an interest rate hike and fundamentals largely positive, with supply still relatively constrained and vacancy rates for commercial real estate at significant lows. In August, real estate will become the S&P 500’s eleventh sector, which is expected to create some forced buying from funds currently underweight REITs, as well as interest from investors looking to exploit this move. Dividends remain high, especially in sectors such as health care, and are far outpacing yields on Treasuries, and REITs have benefited from recent Brexit-induced volatility.
Preliminary estimates for July indicate that the index increased by 4.1 per cent (on a monthly average basis) in SDR terms, after declining by 0.6 per cent in June (revised). The increase was led by the prices of the bulk commodities, LNG and gold. Both the base metals and rural subindices increased in the month. In Australian dollar terms, the index rose by 1.1 per cent in July. Over the past year, the index has fallen by 2.0 per cent in SDR terms and by 3.7 per cent in Australian dollar terms.
Consistent with previous releases, preliminary estimates for iron ore, coking coal, thermal coal and LNG export prices are being used for the most recent months, based on market information. Using spot prices for the bulk commodities, the index rose by 8.3 per cent in July in SDR terms, to be 3.5 per cent higher over the past year.
The Australian equity market (as measured by the S&P/ASX 200) started the year off much like the previous finished, although most of the steam had been taken out of the rally with January producing a solid +1.20% return. February was much more muted with the uncertainty of an imminent reporting season hanging over the market however with better-than-expected results, coupled with softer-than-expected domestic inflation data, March provided some highlights as Australian shares hit new record highs. The quarter ended on a high with March producing +3.27% closing the quarter off with an attractive +5.53%.
2023 made for another very interesting year in investment markets as macro / regime driven events resulted in extreme shifts in investor sentiment on an almost monthly basis. Investors chose to shoot first and ask questions later in what can best be described as a year of maximum noise.
The Australian equity market (as measured by the S&P/ASX 200) started the September quarter with a flurry but ended up in the red as the global “higher-for-longer” narrative (interest rates) coupled with the ever-increasing cost of living concerns caused consumer confidence to wane.