Economic and Investment Update - April 2016
by Lonsec Research
Summary of Key Views
Tactical positioning unchanged
The last quarter saw a pullback in equity markets, with Australian and global equities posting negative returns for the quarter despite an uptick in the market in March. Conversely, perceived ‘defensive’ sectors such as A-REITS, global listed infrastructure and bonds posted positive returns. Lonsec’s tilts away from equities towards cash and alternative assets relative to our strategic asset allocation has dampened some of the downside experienced by equities. We have held our defensive bias since the end of 2015 and have retained our positioning this quarter.
Since the end of the quarter we’ve seen markets continue to rally supported by a short term rally in oil prices, with Brent Crude trading above $40 per barrel compared to sub $30 at the beginning of 2016, coupled with positive news coming out of China with trade numbers exceeding expectations. Despite this, we are closely watching the upcoming earnings season in the US as we have been cautious on strength of company earnings which ultimately underpin share price growth. Economic news from the US remains mixed with some pick up in manufacturing data, while small business confidence remains subdued. Earnings growth within the Australian market is also subdued, particularly in the top 20 stocks by market cap. EPS growth looks stronger in the small cap part of the market, however market volatility remains elevated. Overall, equity valuations don’t look compelling given the earnings profile.
We have held a neutral position to REITs and listed infrastructure. These sectors have done particularly well when markets have pulled back as investors have sought ‘bond proxy’ style investments to provide defensiveness and yield within their portfolios. We recognise that it is probably late in the cycle for such asset classes, however if the Fed remains dovish and global growth remains low, these sectors may continue to perform well.
Within the fixed income part of our asset allocation, we continue to hold excess cash ahead of global and Australian bonds given that neither of these assets classes look compelling from a valuation and risk return perspective. However, we do favour Australian over global bonds, given the positive yields from Australian bonds and the fact that there is more scope for bond yields to fall in the Australian market.
From a macroeconomic perspective, an overarching issue remains what central banks will do as they recognise the limits of monetary policy in countering slowing global growth. Governments may look to intervene, but their scope to act is limited. Outside of macroeconomic and asset class specific considerations, issues such as the UK referendum on where to stay or not within the European Union will continue to cause uncertainty in markets, along with what direction US elections take. While we remain cautious in our asset allocation positioning, we will look to increase our allocation to equities as we see an improvement in the macroeconomic environment, valuations become more attractive and overall market and economic sentiment shows signs of improvement.
Market developments during March 2016 included:
The Australian share market staged a modest comeback in March, only to retreat late in the month as investors refocused on risks to the global economy. The S&P/ASX 200 Index ended the month at 5082.79 points, recovering some of the ground lost in February, but still down 15% on its April 2015 high.
Australian equities, as measured by the S&P/ASX 300 Accumulation Index, returned 4.78% during the month, and -9.27% over the year to March. All sectors were positive, with strong retracements from Resources (6.66%), Energy (6.16%) and Materials (6.05%), and a rebound in Financials (5.89%) following significant declines in the start of the year. Industrials (2.27%) were the underperformers in March, but still the highest-returning sector over a oneyear period, recording 12.75%.
Small cap shares again outperformed the market in March, with the S&P/ASX Small Ordinaries Accumulation Index returning 5.47%. Small cap indices have provided better protection against market falls over the past year, returning 3.72% over the past 12 months (versus the S&P/ASX 200 Accumulation Index return of -9.59%).
Markets rallied in mid-March in response to a dovish turn from Fed Chair Janet Yellen, which appeared at odds with some of her more hawkish colleagues. The FOMC left rates on hold in March, however it provided a lower path for expected future rate rises, with the median expectation for the funds rate at the end of 2016 lowered by 50 bps to 0.75-1.00%.
The US market rose 2.10% following the announcement, which was carried through to the end of the month. The S&P 500 Index finished the month up 6.60%, boosted by positive manufacturing and revised GDP growth data.
Meanwhile in Europe, extraordinary monetary policy settings keep getting more extraordinary. In action evoking President Draghi’s fateful “whatever it takes” speech some four years ago, the ECB cut its deposit rate a further 20 bps to -0.40%, while the main refinancing rate was cut to zero. The European market rallied 3.57% in response to the decision, before falling 5.05% to end the week lower. In the UK, the FTSE 100 gained a modest 1.28% in March, and the German DAX added 4.95% despite subdued manufacturing output.
Financial markets were supported by rising commodity prices, with crude oil ducking above US $40/b towards the end of the month. The MSCI World ex Australia NR Index gained 6.27% in March, with strong growth from Asian markets. The Nikkei 225 Index gained 4.57%, the Shanghai Shenzhen CSI 300 Index gained 11.84%, and the Hong Kong Hang Seng Index gained 8.71%.
Australian bonds returned -0.21% in March as a moderate rise in yields pushed bond values down. The Australian 10-year Treasury yield rose from 2.40 to 2.49, after reaching a high of 2.69 during the month, while 2-year yields rose from 1.77 to 1.90. Global bonds, as measured by the Barclays Global Aggregate Bond Index, returned 0.92% in March amidst falling yields on corporate investment grade and high yield bonds. Monthly returns on global corporate and high yield debt were 2.34% and 4.33% respectively.
Softer economic growth forecasts have again pushed out expectations for a Fed rate increase, while the ECB took action to address persistent weakness in the European economy, cutting the deposit rate further into negative territory and expanding its asset purchase programme. Central bank credibility was on the line in March, although bond markets have reflected a more moderate risk environment compared to the start of the year. Non-investment grade yields came down from 8.64 to 7.83, providing some comfort to recession watchers.
Government bond yields underwent a modest expansion in March. The US 10-year Treasury yield rose from 1.74 to 1.77, and the UK 10-year Gilt yield rose from 1.34 to 1.41. The Japanese government, by far the most indebted in the world, is still borrowing at negative 10-year rates, with yields rising slightly from -0.04 to -0.03 in March. In Europe, government bond yields experienced mild expansion despite further easing from the ECB, with the German 10-year Bund yield rising from 0.11 to 0.15, and the 5-year Bund yield moving slightly higher from -0.41 to -0.33.
REITs (listed property securities)
The S&P/ASX 300 A-REIT Accumulation Index retuned 2.50% in March, underperforming the market but still an attractive asset class for yield hunters. Concerns remain among some investors about the perceived risk associated with high A-REIT valuation multiples, including potentially unsustainable distributions. In the acquisitions space, Investa urged shareholders of its Investa Office Fund (IOF) to vote against a $2.5 billion bid from DEXUS Property Group, arguing the bid undervalues the trust. Globally, REITs returned 9.47% in March (in USD terms), while the FTSE EPRA/NAREIT Developed NR Index (AUD Hedged) gained 7.59%. In the US, REITs returned 10.08% in USD terms, with free-standing retail, data centre, specialty, and self-storage REITS the top performers. Growth in cloud computing and data has driven demand for third-party IT infrastructure, which has been reflected in the REIT market. Self-storage fundamentals remain solid as a result of limited new supply, capital constraints and increased barriers to entry.
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