Economic and Investment Update - May 2015
by Lonsec Research
Summary of Key Views
Australia lags global recovery
The Australian equity market continues to underperform global markets in recent months with banks, consumer staples and resources the main laggards. Australian banks and consumer staples are facing increased competition which has led to earnings growth downgrades. Resources continue to range-trade with no real direction as yet.
We also note the rally in bond yields may have kept a lid on the market, despite the RBA cutting the cash rate to 2.0% in May. Australia’s GDP growth remains robust (2.3%) and inflation remains low (1.3%) but mining continues to slow rapidly and more momentum is required in non-mining sectors. The May Federal Budget was well received with consumer and business confidence lifting throughout May.
A sustainable recovery seems to be taking hold in the US. With the economy improving, the Federal Reserve has wound up its bond purchasing program, with the first interest rate hike expected in 2015, although the Fed has said that it ‘can be patient when beginning to normalise monetary policy’. In response to the Fed gradually tightening monetary policy, the US dollar has rallied 25% in the past six months.
Overall, market conditions remain positive for equities in terms of moderate growth, ve - May ry low interest rates and low inflation but we acknowledge that listed companies, particularly in the large-cap segment, are struggling to generate earnings growth. The FY15 profit season in August 2015 will be the next best chance to assess the FY16 outlook.
There is little income to be found in cash, term deposits and bonds and increasingly the yield on equities is becoming attractive, where it is sustainable. This is particularly the case in Australia, where the market dividend yield of 4.5% (78% franked) remains a key attraction for investors.
The key risks here are:
inflation surprise (would jolt the yield curve higher);
deflation grind (low inflation turns into deflation and growth disappoints); and
geo-political disruption (Ukraine, Middle East, Greece).
Lonsec’s base case remains low to moderate growth,low inflation and low interest rates. Accordingly we retain our overweight growth, underweight bonds and neutral cash weightings.
Market developments during May 2015 included:
The Australian ‘broad cap’ equity market, as measured by the S&P/ASX 200 Accumulation Index, was up 0.40% in May and is 9.93% higher over the year. The month was a tale of two halves, with the market falling 3.50% initially before recovering to post a modest gain. A number of banks, chemical and building material companies reported negative results or issued adverse trading updates during the month. Banks were the worst performing sub-sector, down 3.20% after several of the ‘Big 4’ announced equity raisings in the face of growing regulatory pressure to bolster capital ratios. Meanwhile the Australian Federal Budget delivered tax cuts and accelerated tax write-offs for small businesses, prompting a minor rally in some retails stocks that were perceived to be beneficiaries of a predicted boom in sales of computers and office equipment. Thus, discretionary retail was the best performing domestic sub-sector during May.
The S&P/ASX Small Ordinaries Accumulation Index outperformed its broad cap counterpart, up 2.35% for the month. However, over 12 months the ‘small cap’ market continues to materially lag the broad cap index.
Global equity markets finished the month with little change. The US outperforming (S&P 500 Accumulation Index up 4.37%) while emerging markets heavily underperformed (MSCI Emerging Markets Index down -0.92%). Investor attention during the month was focused on (1) speculation over when the Federal Reserve would start to raise interest rates, and (2) the negotiations between Greece and its international partners to forestall an imminent default given Greece was running out of cash.
European equity markets were all down in May: the German DAX -0.40%, French CAC -0.42% and UK FTSE -0.46%. In Asia, the Shanghai Composite Index experienced a wild ride, up 11% at one point before selling off heavily in the last few days of the month to finish up 4%, as the Chinese central bank cut rates once again. Japan’s NIKKEI 225 up 5.32%, Hong Kong’s Hang Seng Index down -1.90%.
The Australian fixed interest market, as measured by the Bloomberg AusBond Composite Index, was relatively flat, up 0.04% in May. While the Bloomberg AusBond Bank Bill Index, which comprises lower risk and shorter dated securities, finished 0.20% higher. The main catalysts for the initial weakness in the domestic bond market in May was a sell-off in global bonds in addition to the RBA rate-cut announcement to generational lows of 2%.
The Global Fixed Interest market, as measured by the Barclays Global Aggregate Index (Hedged A$), was down -0.26% as the Fed confirmed that it was on a path towards normalisation of interest rates this year. German bund yields continued to rise sharply from record lows reached mid-April.
REITs (listed property securities)
The S&P/ASX 300 A-REIT Accumulation Index gained 2.73% in May – its first positive result in three months. Over 12 months to May, the Index is up 29.34%. However this is likely to soften as the domestic economy faces headwinds from its dependency on resources, a weakening Australian dollar, and challenging leasing conditions driving elevated vacancy rates and incentives.
The G-REIT market, as measured by the UBS Global Investors TR Hedged (A$), was down -0.31% in May. Over the year G-REITs underperformed its domestic counterpart by 12.53% yet still managed to return close to 17% for investors. This was driven by the continual ‘search for yield’ and stable earnings growth.
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