Economic and Investment Update - October 2015
by Lonsec Research
Summary of Key Views
Not out of the woods
An increase in risk aversion swept through global financial markets in the September 2015 quarter. Equity markets retreated, commodity prices fell, government bond yields tightened and credit spreads widened. It is hard to pinpoint a single catalyst but the most obvious negative news was the continued slowdown in China and the apparent bungling of the Chinese authorities in its attempt to halt a sliding Shanghai share market. But the increase in risk aversion was not just about China, there are also concerns about slowing global growth generally, particularly in emerging economies.
At the same time, talk of a rate rise in the US has led to a rising USD, which has become a net negative for global US companies, while a weak oil price also hurts energy stocks. The positives from a low oil price seem to be outweighed by the pressure it puts on major oil and gas producers (Russia, the US, the Middle East, Canada and Australia) and the additional deflationary force that it brings when inflation is already near zero in the developed world.
In addition, the geo-political stakes seem to be rising with Russia testing NATO’s resolve with military interventions in Ukraine and Syria. While the possible outcomes are hard to assess, the influx of migrants from Syria into Europe is very real and one wonders what the implications are for the European economy and its politics. Lastly, let’s not forget that Greece’s debt problem has not really been resolved but just delayed for another day.
What are the positives? Well global growth is still expected to be around 3.1% in 2015 and the US seems stable. Interest rates are very low and central banks are providing additional liquidity in Europe, China and Japan. Inflation is near zero (this could become a negative if inflation turns into deflation), so there is little risk of interest rates rising in the short term. There is still a chance that the US leads a global recovery with Europe gradually improving and Asia stabilising.
That said, we seriously doubt that the US Federal Reserve will increase the cash rate this year, if at all, as it is unlikely that its stated concerns around slowing global growth and low inflation are going to be resolved in the near term. In addition, recent US economic data has generally printed below expectations which has cast doubt over the strength of the US recovery.
Volatility has increased in recent months on a slowdown in global growth, particularly in emerging markets. While the US economy seems stable, its large global companies are not immune to slowing global growth, a strong USD and weak energy prices. From a short-term tactical asset allocation point of view, Lonsec’s maintains an underweight to equities, with a preference for global over Australian equities, with an overweight to cash, Australian fixed interest and alternatives.
Market developments during September 2015 included:
The Australian ‘large cap’ equity market, as measured by the S&P ASX 200 Accumulation Index, once again underperformed its global peers-down -3.0% in September as the market reacted to heightened volatility in global markets. Driven by the broad sell-off in commodity prices, the Energy and Resources sectors were amongst the worst performing sectors in September, shedding 12.5% and 6.6% respectively. Other sectors that lost further pace over September were Banks and Healthcare. The top performing sectors for September were the IT and Industrial sectors, with both sectors recording gains of 5.3% and 1.4% for the month.
The S&P/ASX Small Ordinaries Accumulation Index continued to modestly outperform its large cap counterpart for the month, down -0.53%. However, when compared over the one year period to September, the ‘large cap market’ is still outperforming the small companies benchmark by 4.2%.
The sell-off in global equities resumed in September following heightened volatility in the global markets caused by a quick succession of major events. Prolonged concerns surrounding China’s weakening economy, timing of US interest rate hikes and rout in commodity prices were the main contributors to the sharp decline in global equity prices for the month.
September’s headlines were dominated by the US Federal Reserve’s decision to leave interest rates on hold, citing the weakness in the global economy and benign domestic inflation. In passing down the decision, the central bank has also left the door open for a hike before year-end following continued improvement in its labour market and economic growth.
t indices retreated over September, with the S&P Accumulation Index ending the month -3.2% lower, despite a late month-end rally. Eight out of ten sectors declined led by the materials (-7.6%) and energy (-6.8%) following the subdued outlook for commodities. Major world indices followed the same trajectory with the Japanese Nikkei (-8.0%) German DAX (-5.8%) and UK FTSE (-3.0%) posting losses for the month.
Emerging markets continued to underperform as measured by the MSCI Emerging Markets Index, which was down 1.5% for the month. Detractors at the economy level included Argentina (-11.0%), Russia (-5.3%) China (-4.8%) and Brazil (-3.4%). South Korea (+1.1%) and Malaysia (+0.51) were amongst the few emerging markets to outperform in the month of September.
The Australian bond market ended the month higher due to a rise in risk aversion, stemming from uncertainties surrounding global growth and the timeliness of the Fed Reserve rate hike. The Australian Government 10-year bond yield ended the month lower at 2.6%, indicating an increase in demand for “safe haven” assets in the backdrop of plummeting equity prices. The Australian fixed interest market, as measured by the Bloomberg AusBond Composite Index returned 0.3% and the Bloomberg AusBond Bank Bill Index (which comprises of lower risk and shorter dated securities) finished 0.2% higher. Consistent with its Australian peer, the Global Fixed Interest market, as measured by the Barclays Global Aggregate Index (Hedged A$) was also up 0.8%.
REITs (lised property securities)
The S&P/ASX 300 A-REIT Accumulation Index lost - 0.3% in September, yet continues to outperform general equities, in a low growth, low bond yield environment. Following a sell-off in August, property valuations continue to remain robust with the sector trading on a 3% discount to Net Asset Value and a 27% premium to Net Tangible Asset of late. The Index returned 20.1% in FY15, aided by rising asset value and corporate activity over the past year.
The G-REIT market, as measured by the FTSE EPRA/NAREIT Developed Index (A$) Hedged posted a positive return of 1.4% in September, outperforming its Australian counterpart over the month.
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