Economic and Investment Update - May 2018
by Lonsec Research
Summary of Key Views
Emerging markets on the front line
May was a relatively strong month for markets with the exception of emerging market equities, which retreated by more than 3% during the month. Emerging markets experienced significant outflows in May with over $12 billion in foreign investment exiting the sector. Outflows impacted both debt and equity markets, driven by country-specific issues along with broader geopolitical events, including ongoing concerns over a US-led trade war through to political uncertainly in Italy.
As discussed in last month, Lonsec believes that volatility in markets will be higher than what investors have experienced in recent years. Importantly, volatility is returning to what we think are ‘normal’ levels on the back of an extended period where volatility was at abnormally low levels. While more volatility may be a concern to clients, we believe it will provide for greater investment opportunities for the skilled investor as we see greater dispersion in returns between asset classes, regions, sectors and individual investments in equities. From a valuation perspective, asset classes continue to be largely trading in the fair value to expensive range, however recent volatility has eased valuation pressures in some segments of the market.
Market developments during May 2018 included:
The S&P/ASX 200 Accumulation Index rose 1.1% in May, with the biggest gains coming from the Health Care (+5.6%) and Consumer Discretionary (+5.1%) sectors. Australia’s leading biotechnology business CSL (+9.1%) advanced to its highest price since listing in 1994 after announcing its second profit upgrade in 2018, including better than expected sales. Seven West Media (+47.8%) jumped early in the month after acquiring the free-to-air broadcast rights from Cricket Australia, taking them off channels Nine and Ten.
The Materials sector (+2.0%) was higher in line with a rise in base metal prices, with gains from major miners BHP Billiton (+6.0%) and Oz Minerals (6.4%). Telecommunications (-10.2%) was the worst performing sector, with Telstra (-12.0%) hitting seven-year lows in the wake of multiple network outages during May and ongoing concerns about competition from the NBN. Australia’s large cap shares (measured by the S&P/ASX 50 Accumulation Index) rose 1.0% in May, compared to a 3.7% gain from its small cap peers. Over the past 12 months to the end of May, small caps have outperformed large caps by 17.9%, while large cap shares are lagging the ASX 200 Index over short and medium terms.
Global developed market shares, measured by the MSCI World Ex Australia Index, returned 0.5% through May in AUD terms, bolstered predominately by gains from the United States and United Kingdom. The US S&P 500 Index rose 2.4% in USD terms, with the Information Technology sector (+7.1%) the best performer, contributing 77% of the S&P 500’s gains in May.
Facebook (+11.5%) bounced back despite continued fallout from the Cambridge Analytica scandal, while Apple (+13.1%) moved closer to becoming the first stock to reach a market capitalisation of US $1 trillion.
In Europe, the STOXX Euro 600 Index rose a modest 0.5%, weighed down by Europe’s banks (-9.0%), including major falls from Italian banks like Unicredit (- 21.4%), which were most impacted by uncertainty surrounding Italy’s election outcome and the possibility of an ‘Italexit’. In Asia, Japan’s Nikkei 225 Index fell - 1.2%, Hong Kong’s Hang Seng fell -0.4%, and China’s CSI 300 Index gained 1.5%. Global emerging market shares, measured by the MSCI Emerging Markets Index, fell -3.8% in AUD terms, but have still outperformed developed market shares over the past 12 months.
Australian bonds returned 0.7% in May, with Australian government bonds returning 0.8% and longer-term government bonds (with a maturity of ten years or more) returning 1.3%. Globally, the Bloomberg Barclays Global Aggregate Bond Index (AUD hedged) returned 0.4% as geopolitical tensions pushed safe haven yields lower. After briefly moving into positive territory midmonth, Germany’s 5-year Bund yield ended May at - 0.27% as the prospect of a eurosceptic coalition in Italy solidified.
After hitting 3.1% earlier in the month, the US 10-year Treasury yield finished the month just above 2.8%, with the spread between 10-year and 2-year yields narrowing to 43 basis points. While the market is concerned about the flatness of the yield curve (a negatively sloping yield curve is correlated with recessions), there is some debate about whether central bank policies globally are creating a false signal. The Japanese 10-year yield fell from 0.06% to 0.04%, still hovering above the Bank of Japan’s zero yield target, which the Bank hinted could be scrapped even before inflation reaches the 2% target.
REITs (listed property securities)
The S&P/ASX 200 A-REIT Accumulation Index rose 3.1% in May as modest falls in short-term yields lifted the sector during the month. Almost all major A-REITs gained, led by Investa Office Fund (+15.0%), which received a $3.1 billion bid from US fund manager Blackstone. Shopping centres had another positive month, with gains from Vicinity Centres (+9.4%), which will sell $1 billion of ‘non-core’ sub-regional centres to focus on premium malls, and Scentre Group (+3.7%), which may be one of the beneficiaries of the sale of Westfield if former shareholders feel the need to reinvest their cash payout in shopping centre stocks.
Diversified property managers Abacus (+6.1%) and GPT Group (+3.9%) also had a solid month. Globally, the FTSE EPRA/NAREIT Developed Ex Australia Index (AUD hedged) rose 2.2% in May. In the US, the REIT recovery gathered more steam in what was the best month for REITs so far in 2018. Mall REITs, which have suffered in recent quarters from tenant bankruptcies, continued their turnaround, returning 9.4% in May, while hotels returned 10.9% and health care facilities 7.4%.
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