Economic and Investment Update - September 2015
by Lonsec Research
Summary of Key Views
August equity market correction
Genuine concerns over a slowdown in global growth, particularly in Asia, have led to a correction in global equity markets. The key to markets stabilising will depend on Chinese actions to restore confidence or simply market’s falling to a point where company valuations become compelling to longer term investors.
Concerns over global growth have been building for most of 2015 after a sequence of events including: a crash in the oil price, Greece getting very close to default and exiting the European Union and an apparent slowdown in China.
China has continually downgraded its growth forecasts this year and its recent manufacturing and export data was well below expectations. Financial markets started to get more concerned when Chinese authorities tried to ‘prop up’ the Chinese share market after it declined by 30% from its June 2015 high (and after gaining 136% in the previous year) and then moved to devalue the Yuan for the first time in decades. The recent port explosion in Tianjin has only added to doubts over the competence of the Chinese administration.
At the same time, the US economy has been on the improve and the US Federal Reserve has been contemplating increasing US interest rates in late 2015. The combination of solid growth in the US and soft growth outside of the US had led to a rising USD, falling commodity prices and general weakness in equity markets, outside of the US.
The US share market had been quite resilient for most of 2015, on enthusiasm for the US recovery story, but in recent days it has seemingly succumbed to nagging concerns about global growth, a strong USD and a very weak oil price. The recent US reporting season showed a general trend of soft revenue growth with EPS largely boosted by efficiency gains and share buybacks. The rising USD has also started to crimp revenue for US companies operating in Europe and Asia. The recent devaluation of the Yuan only added to concerns about USD strength. In addition, the weak oil price hurts major US energy companies.
Reasons to remain positive on a long term basis include: very low interest rates (with room to go lower in Australia); low inflation; the generally strong balance sheets of Australian banks, companies & government; and the attractive dividend yields and lower PE multiples now on offer.
Lonsec moved to a short term underweight equities call in our Quarterly Outlook issued in early July, based on valuations and potential for increased market volatility. At this stage, we remain cautious on the global growth outlook and will be issuing any revisions to our tactical asset allocation views in early October 2015.
Lonsec also reiterates that within equity portfolios, ensuring diversification of strategies is an increasingly important aspect of portfolio construction. Introducing risk controlled strategies into an equities portfolio can offer an element of downside protection when markets become volatile. It is also key at this point to remember why we have diversified multi asset portfolios. The rally in sovereign bonds over in risk off periods is quite clearly a ‘flight to safety’, therefore, the fall in equity market prices has been somewhat offset by the rise in bond prices. Diversification is key, as is understanding not just the return profile of a diversified portfolio, but its risk attributes as well.
Market developments during August 2015 included:
The Australian ‘large cap’ equity market, as measured by the S&P/ASX 200 Accumulation Index, underperformed its global peers – down -7.8% in August. Banks were one of the worst performing domestic sub-sectors, posting a total return of -12.6% during the month, weighed down by $8 billion of equity raisings. Domestic Energy continued to perform poorly relative to the global Energy sector. However, Australian Mining & Metals bucked this trend, likely reflecting the rise in the iron ore price. The Australian market was also pre-occupied with reporting season, the key feature of which was weak FY16 guidance despite inline FY15 results for many high profile companies. The S&P/ASX Small Ordinaries Accumulation Index outperformed its large cap counterpart, down -4.9%. Yet, over 12 months, the large cap market is ahead of the smaller companies benchmark.
Volatility across global share markets kicked up a gear in August, with a variety of issues concerning investors. The major culprit was a series of Chinese currency devaluations and the related issue of China’s faltering economy. This led to a sharp rise in risk aversion which saw equity market volatility spike to multi-year highs and bond yields fall. Almost all equity markets posted double-digit losses at their lows on the 24th or 25th of August, before rallying in the last few trading days of the month. In the US, the S&P 500 Accumulation Index finished the month -2.7% lower despite reasonably strong fundamentals. Almost three-quarters of the S&P 500 companies that had reported by month’s end, beat earnings expectations according to FactSet. The MSCI World Accumulation Index was down also down -4.0% in August. Globally, defensive sectors such as Telecommunications and Utilities outperformed cyclical sectors such as Materials and Consumer Discretionary. Mining & Metals were the worst performing sub-sector globally.
Emerging markets, particularly China (-11.7%), underperformed, as measured by the MSCI Emerging Markets Index, which was down -6.5%. Aside from China, the largest losses came from Brazil (-8.4%) and Malaysia (-6.9%). Russia (+1.2%), Argentina (-1.3%) and Mexico (-2.1%) were the best performers.
Demand for “safe haven” sovereign bonds increased as global equity markets corrected leading to a new wave of low yields as their prices increased. However, the Australian fixed interest market, as measured by the Bloomberg AusBond Composite Index, was up 0.64%. The Bloomberg AusBond Bank Bill Index, which comprises lower risk and shorter dated securities, also finished 0.18% higher. The Global Fixed Interest market, as measured by the Barclays Global Aggregate Index (Hedged A$) was down -0.10.
Hedged A$, also edged up close to 1.0%.
REITs (lised property securities)
The A-REIT sector has been on a negative skew since peaking in January 2015, yet continues to outperform general equities in a low growth and low bond yield environment. The S&P/ASX 300 A-REIT Accumulation Index fell -4.0% in August representing the level of fear dominating markets over the month. Following FY15 reporting season, A-REIT Net Operating Income growth averaged +2.7% across the sector in the period to June 2015, up 1.0% over the year, with all sub-sectors improving.
The G-REIT market, as measured by the FTSE EPRA/NAREIT Developed Index (A$) Hedged posted a negative return of -5.9% in August.
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