Market Review

Australian Economy

Economic data released over the month was messy, for example; a pronounced fall in September quarter construction activity, a fall in September quarter private new capital expenditure and continuing softness in credit growth.  The good news is that business investment plans for the current financial year continue to improve, with capital spending plans the fastest in six years as the slump in mining investment slows and non-mining investment improves. So, business investment should help provide an offset to the downturn in the housing cycle.

Stronger Australian budget position, is likely to see the Government announce tax cuts ahead of next year’s budget brought forward to April 2, clearly designed to clear the way for an election in May.  The upside of bigger and earlier tax cuts is that it will inject some spending power into household budgets providing a partial offset to what looks like being an intensifying negative wealth effect from falling house prices on consumer spending next year.

November posted a positive return for shares with global shares gaining 1.2% in local currency terms conversely Australian shares fell by 2.2%. It’s been a bumpy ride for share markets of late, partly due to a combination of; Trump, Brexit, Trade Wars, changing PMs and a Royal Commission.

Global Economy

As in recent months, geopolitical events dominated market moves over the course of November. The outcome of the US midterm elections was broadly as markets expected. The Democrats took control of the House of Representatives and the Republicans increased their majority in the Senate.

The global growth momentum has been sustained in 2018, buoyed by a strong fiscal expansion in the USA, which has largely offset slower growth in some other large economies. A review of global economic indicators suggests that global economic growth has remained steady, exceeding 3% in annualised terms over the first 6–9 months of 2018. However, expectations over the next 6–12 months point to some softening in economic momentum.

Economic confidence and sentiment indicators in the USA are near recent historical highs, reflecting strong jobs growth, major income and business tax cuts and buoyant economic activity—in the first three-quarters of 2018, gross domestic product (GDP) was 2.8% higher than a year earlier. However, there is growing evidence that firms are facing capacity constraints, which will restrain growth in the coming quarters despite the support of fiscal stimulus measures.

Reaction to the outcome of the meeting between President Trump and Xi Jinping at the G20 leaders’ summit in Argentina will be a key driver of markets for the remainder of the calendar year.

The picture in Europe is not so rosy, sentiment slipped for the 11th month in a row in November, unemployment was unchanged at 8.1% in October, bank lending slowed, and core inflation surprisingly fell back to just 1% year-on-year in November, all of which will keep the ECB cautious.

Japanese jobs data slowed marginally in October but remains strong, industrial production rebounded after weather disruptions and core inflation measures in Tokyo tracked sideways at a low level. Ultra-easy Bank of Japan monetary policy is set to continue.

Chinese official PMIs (Purchasing Managers’ Index), a proxy for the economic health for manufacturing and service sectors, softened further in November and momentum in industrial profits continued to slow in October, which is all

consistent with a further gradual slowing in growth and points to a more vigorous ramp up in policy stimulus.

Table 1: Market Performance – Periods to 30 November 2018

Sector 1 Month % 3 Months

%

1 Year

%

3 Years

% pa

5 Years

% pa

Australian Shares -2.2 -9.3 -1.0 7.7 5.8
International Shares ($A) -1.8 -6.6 4.2 8.2 11.7
Emerging Market Shares ($A) -3.2 -1.3 5.5 -0.6 5.4
Australian Listed Property -0.4 -5.2 1.4 8.0 11.6
International Listed Property ($A) 0.7 -3.0 6.3 5.5 11.3
Australian Direct Property 0.6 2.6 11.4 12.9 12.1
Australian Fixed Interest 0.2 0.3 2.5 3.3 4.5
International Fixed Interest (Hedged) 0.6 0.5 0.9 2.8 4.5
Cash (BAUBIL) 0.2 0.5 1.9 1.9 2.2
Change over the month
Australian Govt. 10 yr Bond Yield 2.68% 0 bps
AUD/USD $0.73 $0.02

Australian Shares (S&P/ASX 200 Accumulation Index)

The Australian share market declined 2.2% in November to close at a near two year low, as commodity price declines and global market jitters weighed down equity returns.

Among the S&P/ASX 200 sectors, Financials led the way, gaining 1.4%, followed by Information Technology (+1.0%). Energy brought up the rear, declining 10.3% in the month on the back of a steep decline in oil prices, followed by the Telecom sector falling 4.1%. Even A-REITs didn’t escape returning -0.4%.

Trailing P/E Ratio was at 15.9x at the end of the month and above the long-term average of 16.7x. The forward P/E Ratio is at 17x. P/BV is at 1.9x. The VIX was at 21.6 indicating high levels of market volatility.

International Shares (MSCI World ex Australia, Net $A)

The past month has been a roller coaster ride for equity markets with the last six months especially challenging. Three main issues dominated – China’s financial reform (and intended slowdown), Trumps trade war and rising US interest rates. Key lesson, China’s impact on the world economy and markets is bigger than most previously perceived. As the world’s largest physical market for everything from handbags to cars to copper, it is no longer the case of when US sneezes the world catches a cold. And, we can’t forget the Brexit comedy!

Due to a change in the US Federal Reserve’s interest rate outlook, share prices posted gains in November with a late-month rally. International shares on an unhedged basis dropped 1.8% in November compared to international shares on a hedged basis which rose 1.2%. Currency impact over the month again played a significant role. The AUD benefited from hopes of a resolution to US-China trade frictions ahead of the much-anticipated meeting between US President Trump and his Chinese counterpart Xi Jinping at the G20 summit.

The AUD rose 3.4% against the Japanese yen, 3.3% against the US dollar (USD), 2.8% against the euro and 2.7% against the British pound. The broader Australian Trade-Weighted Index1 closed the month 2.3% higher.

The index finished trading at a P/BV of 2.3x and a P/E Ratio of 16.4x. The forward P/E Ratio is at 13.9x.

US share market was volatile over the month of November (-1.1% unhedged and +1.9% hedged), depressed by trade worries, and disappointing US economic data e.g. core durable goods orders were flat and weekly jobless claims hit highs not seen since the summer.

Developed European markets lost ground (-3.9% unhedged and -0.9% hedged). On the positive side, Danish shares were the top performers. Italian shares were volatile throughout the month due to continuing tensions with the European Union over the Italian government’s plans to increase spending. British shares declined as the European Union (EU) and UK reached a draft deal that outlined future ties between the EU and the UK, although domestic opposition could complicate any progress. Stocks in Norway―one of Europe’s largest oil producers―were hurt by falling oil prices. Ireland and Finland also fell.

Developed Asian markets were mostly negative, though Hong Kong was a bright spot. Japanese shares were flat for the month, as a late-month rally lifted shares out of the red. Disappointing Japanese economic news weighed on the market, as data released during the month showed that the Japanese economy contracted by a 1.2% annualised rate in the third quarter.

Emerging Market Shares (MSCI EM, Net $A)

Emerging market shares bounced back into positive territory in November returning 6.8%. The index ended trading at a forward P/E Ratio of 14x.

AREITs (S&P/ASX 200 A-REIT Accumulation Index)

Australian listed property fell 0.4% during the month. The sector ended trading at approximately 15.1% premium to Net Asset Value with forecast earnings yield for FYe 2019 DPS of 5.5%.  These multiples look attractive, especially given the current 260 bp premium to 10-year bonds (2.7%). Gearing on a look-through basis was at 29%.

 G-REITs (FTSE EPRA/NAREIT Developed ex-Australia Index)

G-REITs on an unhedged basis was up 0.7% and on a hedged basis returned 3.6%. Currency had an impact over the month.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of 0.6% over the month. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties continued to range between 5.2% – 7.3%.

Australian Fixed Interest (Bloomberg AusBond Composite Index)

Australian fixed interest rose by 0.243% over the month. Australian government 10-year bond yields fell by 4bps to 2.60% while 3-year single A corporate credit spreads increased from a revised figure of 0.90% to 0.97%.

International Fixed Interest (Citigroup World Govt., Hedged to AUD)

International fixed interest returned 0.44% over the month (Barclays). The 10-year US government bond yield fell by 15bps to 2.99% while the US corporate investment-grade credit spread increased from 1.58% to 1.84%.

Australian Economy

Australia was a bit quiet on the economic data front over the month, only notable piece of data was a rise in CBA’s business conditions PMI, albeit it remains well down on last year’s high, but skilled vacancies fell again in October and the trend is now down for seven months in a row pointing to a slowing in employment growth. Comments by RBA Governor Lowe provided more interest though around credit tightening and his concern that the major lending institutions may have gone a bit too far.

October was a damaging month for shares with global shares losing 6.8% in local currency terms and Australian shares losing 6.1%. It’s possible that following top to bottom falls of 9% for global shares, 11% for Australian shares, 21% in emerging markets and 31% in Chinese shares we have now seen the low in the share market rout.

Global Economy

The global economy has been pre-occupied with the US/China trade conflict, nagging markets since around March. It stepped up a notch after last month’s speech by US Vice President Mike Pence indicating that US gripes with China extend beyond trade which led many to talk of a new Cold War – the implication of which is less trade and occasional military tensions which implies lower economic growth and lower price to earnings multiples. However, many economists believe it’s still not as bad as it looks.

  • So far only 12% of US imports have been subject to a tariff hike averaging 15%, which is equivalent to an average tariff hike of 1.8% across all imports. Many economists view this as a non-event when compared to 1930 which saw a 20% tariff hike on all imports.
  • While initially the US seemed to be picking trade fights with all major countries, it has since renegotiated trade agreements with South Korea and Canada/Mexico and is negotiating with Europe and Japan. This indicates that Trump is not interested in trade wars with everyone and that he is not anti-trade per se but wants “fairer trade” for the US.
  • Trump’s comments expressing optimism about a deal with China should be treated with scepticism as they came just before the US midterm elections, they do highlight cause for optimism that a deal will be reached eventually. Trump would want a deal well before he faces re-election in 2020. With China already lowering tariffs, improving intellectual property protections and softening joint venture requirements the outlines of a deal are starting to become apparent and Chinese Vice President Wang has indicated China is ready to negotiate with the US.

Table 1: Market Performance – Periods to 31 October 2018

Sector 1 Month % 3 Months

%

1 Year

%

3 Years

% pa

5 Years

% pa

Australian Shares -6.1 -5.9 2.9 8.2 6.0
International Shares ($A) -.54 -0.9 9.6 8.1 13.4
Emerging Market Shares ($A) -6.8 -7.3 -5.4 6.8 6.8
Australian Listed Property -3.1 -2.2 7.3 7.1 11.1
International Listed Property ($A) -1.6 0.0 9.5 3.9 11.2
Australian Direct Property 0.4 2.4 11.5 13.0 12.2
Australian Fixed Interest 0.5 0.9 3.1 2.9 4.4
International Fixed Interest (Hedged) 0.0 -0.4 0.5 2.7 4.4
Cash (BAUBIL) 0.2 0.5 1.9 1.9 2.2
Change over the month
Australian Govt. 10 yr Bond Yield 2.68% 5 bps
AUD/USD $0.71 -$0.01

Australian Shares (S&P/ASX 200 Accumulation Index)

The Australian share market suffered despite mostly favourable local economic data. Negative factors impacting the local market included concern that a credit squeeze hurting housing might intensify after the release of the interim report of the Hayne Banking Inquiry.

Australian shares fell 6.1% over the month of October. Weakest sectors were Materials off 11.2% followed by Small Industrials (-10.6%) and Energy (-10.5%). Best performing sectors were defensive ones, A-REITS (-3.1%) and Utilities         (-3.9%).

Trailing P/E Ratio was at 16.9x at the end of the month and above the long-term average of 16.7x. The forward P/E Ratio is at 15x. P/BV is at 2.0x. The VIX was at 16.2 indicating high levels of market volatility.

International Shares (MSCI World ex Australia, Net $A)

No equity market escaped October’s rout, led by US tech stocks. Having accounted for a big chunk of US share market gains this year, the US tech sector has corrected around 13%, but that still leaves it vulnerable to relatively high valuations (Nasdaq is on a PE of 42 times), sales growth slowing down for some tech companies and the prospect of increasing regulation. There is a base case that the US share market will start to see a rotation from expensive tech to cheap cyclical stocks (with many trading on forward PE’s of less than ten times).

International shares on an unhedged basis dropped 5.4% in October compared to international shares on a hedged basis which fell 6.8%. Currency impact over the month played a significant role, AUD gaining 2.1%  against the USD. The index finished trading at a P/BV of 2.4x and a P/E Ratio of 19.8x. The forward P/E Ratio is at 13.8x.

All major markets suffered in October, on an unhedged basis the US market was down 5%, Europe 5.7%, Japan 6.5% (unhedged) and emerging markets were off 6.8%.  Currently it is unclear whether it will remain just a correction or maybe slide deeper into a bear market. A bear market is when the price of an investment falls over time. It begins after prices have fallen 20 percent or more from their 52-week high. The more common view is its unlikely we are sliding into a deep or grizzly bear market as the conditions are not in place for recession in the US, globally or Australia.

Emerging Market Shares (MSCI EM, Net $A)

Emerging market shares were negative over the month returning -6.8%. The index ended trading at a P/E Ratio of 14.3x.

AREITs (S&P/ASX 200 A-REIT Accumulation Index)

Australian listed property fell 3.1% during the month. The sector ended trading at approximately 1.0% premium to Net Asset Value with forecast earnings yield for 2018 at 6.4%. Gearing on a look-through basis was at 22%.

 G-REITs (FTSE EPRA/NAREIT Developed ex-Australia Index)

G-REITs on an unhedged basis fell 1.6% and on a hedged basis returned -1.8%. Currency had an impact over the month.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of 0.4% over the month. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties continued to range between 5.4% – 7.5%.

Australian Fixed Interest (Bloomberg AusBond Composite Index)

Australian fixed interest rose 0.484% over the month. Australian government 10-year bond yields fell by 5bps to 2.64% while 3-year single A corporate credit spreads increased from a revised figure of 0.88% to 0.91%.

International Fixed Interest (Citigroup World Govt., Hedged to AUD)

International fixed interest returned -0.27% over the month. The 10-year US government bond yield increased by 8bps to 3.14% and the US corporate investment-grade credit spread increased by 15bps to 1.58%.

 

Australian Economy

Australian economic data was mixed over the month. Retail sales improved in August, business conditions Purchasing Managers’ Indexes remained good and the trade surplus improved slightly, while home prices are continuing to fall, new home sales are falling and building approvals are trending down, pointing to slowing dwelling investment. It should also be noted that the improvement in retail sales was after a flat July, so growth in the September quarter is on track to slow from the June quarter. Also, trade is on track to make little if no contribution to September quarter gross domestic product growth.

Against this back drop it’s not surprising to see the Reserve Bank of Australia leaving interest rates on hold again this month. The central bank can point to the continuing global expansion, above trend gross domestic product growth, an increase in the terms of trade and an improving labour market. However, against this, uncertainty remains high regarding consumer spending, underemployment remains very high, the drought will have a negative impact, house prices are continuing to fall in Sydney and Melbourne, credit conditions have tightened, and wages growth and inflation remain very weak. Many commentators’ views are that that the central bank will keep cash rates on hold out to 2020 at least, and the next move in rates could still turn out to be a rate cut given the risks around falling house prices and the threat this poses to consumer spending.

Global Economy

US economic data remained robust with strong Institute for Supply Management business conditions readings and strong labour market data. While payroll employment rose a less than expected 134,000 in September, this was likely impacted by Hurricane Florence and, in any case,

August US employment growth was revised up by 69,000 taking it to a very strong 270,000, and unemployment fell to a 48 year low of 3.7%. Wages growth slipped back to 2.8% year-on-year from 2.9% and so remains relatively benign, and still a long way from the 4% plus growth rate that helped drive the tight US monetary policy that preceded the last three US recessions. However, it remains in a gradual rising trend, which is consistent with the US Federal Reserve continuing to raise rates every three months, with the next hike being in December. Meanwhile, various US Federal Reserve speakers reiterated that the cash rate will likely eventually have to move to ‘neutral’ of around 3%, and above highlighting that market expectations for just three hikes over the next two years remain too dovish, which in turn implies more adjustment ahead in market expectations, putting further upwards pressure on bond yields.

Has the Fed “gone crazy” and “out of control” as Trump has claimed by ra? No – in fact it has been very responsible in raising rates back towards more normal levels because economic conditions justified it but doing so in a gradual manner because inflation has been benign. That said, Fed Chair Powell’s comments that seemed to swing from leaning dovish and channelling 1990’s Alan Greenspan just a few weeks ago to sound more hawkish recently may have confused things a bit, when in reality nothing was really changing. While Trump’s regular criticism of Fed rate hikes will not stop them from doing what is necessary for the economy, there is a risk that he will blame the Fed for the next inevitable downturn and this may threaten its independence. History tells us that when politicians control central banks the job is done badly.

Japan’s Tankan September quarter business conditions indexes softened for large companies, but overall remain solid. Household spending accelerated, but wages growth slowed.

Chinese manufacturing conditions Purchasing Managers’ Index slowed in September, consistent with tariffs starting to impact. However, this was offset by a rise in the non-manufacturing conditions Purchasing Managers’ Index, suggesting that overall growth is holding up well, helped by policy stimulus.

On the political front in Europe, the details of Italy’s budget plans were not as bad as feared, reducing the risk of a full speed ‘head on’ with the European Commission. Also, the Christian Social Union’s loss in Bavaria was not as bad as feared, together taking a bit off pressure off Chancellor Merkel. So, no Euro disaster brewing on either front.

UK Brexit uncertainty continues, with the Irish border remaining a sticking point. The risk of a ‘no-deal Brexit’ (which would probably knock the United Kingdom into recession), a new election, or another referendum is significant, but some sort of last-minute deal that punts off details for a future resolution remains the most likely scenario. It’s hardly ever that such deals are resolved ahead of when they really need to be.

Table 1: Market Performance – Periods to 30 September 2018

Sector 1 Month % 3 Months

%

1 Year

%

3 Years

% pa

5 Years

% pa

Australian Shares -1.3 1.5 14.0 12.1 8.2
International Shares ($A) 0.6 7.4 20.8 12.4 15.2
Emerging Market Shares ($A) -0.6 1.0 7.6 11.2 9.1
Australian Listed Property -1.8 1.9 13.2 10.0 12.4
International Listed Property ($A) -2.1 1.9 13.4 5.8 11.9
Australian Direct Property 0.3 0.9 9.8 12.6 11.9
Australian Fixed Interest -0.4 0.5 3.7 2.9 4.3
International Fixed Interest (Hedged) -0.1 -0.6 1.0 2.8 4.6
Cash (BAUBIL) 0.2 0.5 1.9 1.9 2.2
Change over the month
Australian Govt. 10 yr Bond Yield 2.63% 4 bps
AUD/USD $0.72 -$0

Australian Shares (S&P/ASX 200 Accumulation Index)

The Australian share market suffered despite mostly favourable local economic data. Negative factors impacting the local market included concern that a credit squeeze hurting housing might intensify after the release of the interim report of the Hayne Banking Inquiry.

Australian shares fell 1.3% over the month of September. There were some strong sector gains in September especially from Energy (4.3%) and again Telecommunication Services (4.2%).  Weakest performing sectors were Industrials (-7.7%), Consumer Discretionary (-4.1%), Consumer Staples (-2.7%) and A-REITs (-1.8%).  Trailing P/E Ratio was at 16.2x at the end of the month and above the long-term average of 15.5x. The forward P/E Ratio is at 16.3x. P/BV is at 2.1x. The VIX was at 11.9 indicating very low levels of market volatility.

International Shares (MSCI World ex Australia, Net $A)

Share-market performances in September varied widely again ranging from Japan’s Nikkei lifting by 3.0%, to Australia’s ASX 200 falling by 1.3%. The US S&P 500 eked out a 0.4% gain in September, notwithstanding an intensifying trade war with China and the latest 25bps rate hike by the Federal Reserve (Fed).

International shares on an unhedged basis rose 0.6% in September compared to international shares on a hedged basis which rose 0.8%. Currency impact over the month was minor, AUD losing 0.1% against the USD. The index finished trading at a P/BV of 2.6x and a P/E Ratio of 20.1x. The forward P/E Ratio is at 15.7x.

Emerging Market Shares (MSCI EM, Net $A)

Emerging market shares were negative over the month returning -0.6%. The index ended trading at a P/E Ratio of 14.3x.

AREITs (S&P/ASX 200 A-REIT Accumulation Index)

Australian listed property fell 1.8% during the month. The sector ended trading at approximately 1.1% premium to Net Asset Value with forecast earnings yield for 2018 at 6.6%. Gearing on a look-through basis was at 23.0%.

 G-REITs (FTSE EPRA/NAREIT Developed ex-Australia Index)

G-REITs on an unhedged basis fell 2.1% and on a hedged basis returned -1.82%. Currency had a minor impact over the month.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of 0.3% over the month. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties continued to range between 5.5% – 7.5%.

Australian Fixed Interest (Bloomberg AusBond Composite Index)

Australian fixed interest rose 0.43% over the month. Australian government 10-year bond yields rose 17bps to 2.69% while 3-year single A corporate credit spreads fell 5bps to 0.86%.

International Fixed Interest (Citigroup World Govt., Hedged to AUD)

International fixed interest returned -0.38% over the month. The 10-year US government bond yields rose 20bps to 3.06% and US corporate investment-grade credit spread fell by 10bps to 1.43%.