Market Review

Australian Economy

The ongoing rally in Australian government bond yields received a further boost following an escalation in US-China trade tensions and forward guidance from the Reserve Bank of Australia (RBA) that an extended period of low interest rates was required for it to meet its employment and inflation objectives. Sentiment shifted from ‘risk-on’ to ‘risk-off’, with equity markets weaker and credit spreads widening.

Australian economic readings continued to provide mixed signals and partial indicators point to another quarter of sub-trend growth in the upcoming release of the June quarter national accounts. While retail sales rose by a better than expected 0.4% in the month of June, volume growth over the quarter was up by only 0.2% and points to sluggish consumption growth.

Construction work completed data for the June quarter was softer than expected, falling 3.8%. Total residential spending fell 5.1% and points to dwelling investment being a drag on economic growth over the June quarter. Business investment remains sluggish, with private capital expenditure falling 0.5% over the June quarter.

On the stronger side was Australia’s trade balance, which moved from a $6.1bn surplus to an $8bn surplus in June. Net exports are poised to add to economic growth over the June quarter.

Against this backdrop, the RBA released its updated economic forecasts. Their central case view is for economic growth to lift from 2.5% in 2019, to 2.75% in 2020 and 3% in 2021. Given the amount of slack that still has to be absorbed, the RBA have inflation lifting at a slower rate, with core inflation only reaching 2% in the second half of 2021.

In light of offshore and domestic developments, many commentators have built in a further two cuts in the cash rate, with a move to a 0.75% cash rate in November and a move to a 0.50% cash rate in February 2020. This stimulus will build on the pro-cyclical pulse the economy is receiving from earlier cuts to the cash rate, the first tranche of tax relief worth around 0.5% of GDP, a relaxation in macro-prudential policies, a lower exchange and stabilisation in house prices. Thereafter, it is expected that the cash rate will remain at 0.50% for an extended period.

Investors sought “safe-haven” assets in August and, as a result, the AUD depreciated against other major currencies. The Aussie finished 1.6% lower against the US dollar at US$0.6737, 0.8% lower against the euro and 3.9% lower against the yen. However, it gained 1.9% against yuan as the Chinese currency was allowed to devalue against the greenback.

Global Economy

August saw global stock markets decline while perceived safe-haven assets such as bonds outperformed amid escalating worries over trade and growth. A closely watched US bond market indicator suggested rising recession risk.

In the US, shares fell amid growth worries. The Treasury yield curve inverted for the first time since 2007, magnifying concerns that the economy may be heading into recession. Government bond yields declined significantly (meaning prices rose) amid the various geopolitical concerns. The US 10-year government bond yield fell 35 basis points, closing the month at 1.50%, a three-year low, while the two-year yield also ended at 1.50%.

UK: Figures from the Office for National Statistics revealed GDP fell 0.2% in Q2, following 0.5% growth in Q1. The biggest drag on growth in the quarter was a reduction in inventories in the run up to the initial 31 March Brexit deadline.

US: US equities declined in August, although the falls were less pronounced than in other major markets. The Federal Reserve (Fed) cut interest rates, as expected, at the end of July. The Fed’s comments indicated that the move was an adjustment rather than the start of an easing cycle, which seemed to disappoint investors concerned about an economic slowdown.

The yield on two-year US Treasuries briefly rose above those on the 10-year bond. This represents an in-version of the yield curve, which is regarded as an indicator of a forthcoming recession.

China: China posted a negative return but marginally outperformed. The US announced 10% tariffs on $300 billion of Chinese goods with effect from 1 September, albeit around half of these were later delayed to 15 December. The renminbi subsequently depreciated beyond the symbolic 7-per-US-dollar threshold, and in response the US Treasury labelled the country a currency manipulator. The Chinese authorities retaliated to trade actions with tariffs on $75 billion of imports from the US, and also suspended new US agricultural product purchases. Meanwhile, fresh policy support was announced in response to domestic economic weakness.

Europe: Eurozone shares ended lower in August with the MSCI EMU (Economic and Monetary Union) index returning -1.2%. Weak economic data from Germany weighed on stock markets while Brexit uncertainty remains another key concern for markets.

In Germany, the “composite purchasing managers’ index (PMI) came in at 51.4, indicating the economy is expanding. However, the manufacturing PMI came in at 43.6, well below the 50 mark that separates growth from contraction. The weak data raised suggestions that Germany’s government could increase spending in order to try and fend off a recession.

Political uncertainty was the theme of the month in Italy after the break-up of the governing coalition of the right-wing League and populist Five Star.

Emerging Markets: Emerging market equities lost value with further strengthening of the US dollar exacerbating wider risk aversion. The MSCI Emerging Markets Index decreased in value and underperformed the MSCI World. Amid rising uncertainty, those markets most sensitive to US dollar strength came under pressure. These included Turkey and South Africa, but also Argentina where surprise primary election results triggered a major sell off in equities and the currency.

In conclusion: Markets continue to be supported by liquidity. There were further dovish comments from both the US Federal Reserve (Fed) and the European Central Bank (ECB) over the month, with both central banks focused on pre-empting further economic weakness and suppressing the potential appreciation of their respective currencies. The challenge for markets is that global trade data remains soft. There are also some concerns about the Fed’s ability to ease aggressively when confronted with the strength of the US labour market.

Table 1: Market Performance – Periods to 31 August 2019

Sector 1 Month
%
3 Months
%
1 Year
%
3 Years
% pa
5 Years
% pa
Australian Shares -2.4 4.2 9.0 11.4 7.9
Australian Shares Small Cap -3.9 1.4 0.9 8.4 7.8
International Shares Ex-Aus (Unhedged) 0.3 8.0 7.6 13.7 13.5
International Shares Ex-Aus (Hedged) -1.9 5.1 1.1 10.0 7.6
Emerging Markets (Hedged) -2.5 1.0 -2.8 7.3 4.3
Emerging Markets (Unhedged) -2.7 2.7 2.7 9.7 7.2
Australian Listed Property 1.2 8.2 19.4 8.6 13.0
International Listed Property ($A) 4.5 7.0 16.9 9.4 13.1
Australian Direct Property 0.1 2.0 7.9 11.1 11.7
Australian Fixed Interest 1.5 3.5 11.2 4.7 5.3
International Fixed Interest (Hedged) 2.3 4.2 10.0 3.9 5.1
Cash (BAUBIL) 0.1 0.3 1.8 1.8 2.0
Change over the month
Australian Govt. 10 yr Bond Yield 0.95% -36 bps
AUD/USD $0.67 -$0.01

*as at 30 June 2019

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

The S&P/ASX 200 Accumulation Index took its first monthly loss for the year in August, falling -2.4%.  Trade war fatigue hit global equity markets in August after another bout of Trump tariff escalation. This was amplified by deterioration in industrial production indicators in China and Germany.

Powerful macro themes flowed into local sector returns. Defensive sectors, cushioned by falling bond yields, continued to post solid gains: Staples returned +0.0%, Healthcare +3.6%, Real Estate +1.2% while cyclical underperformance continued; the Energy sector lost -5.6%, Metals and Mining -8.0% and Materials (ex-mining) -7.5%.  Exceptions to this general trend were Consumer Discretionary (which rose +0.2%) and Communications Services (which fell -4.5%). Discretionary was stronger following continuing recovery in auction clearance rates and anecdotal evidence of improving consumer activity. Earnings downgrades to Telstra (-4%) held back the communication services sector.

The index finished trading at a P/BV of 2.1x and a P/E Ratio of 17.8x and equity yield (dividend) of 4.0%.

The VIX was at 14.1.0 (the average since 01.10.2010 is 16.4) indicating below average level of market volatility.

Australian Shares Small Cap (S&P/ASX Small Ordinaries Index)

The Small Ords Accumulation index gave back most of its July gains in August with a drop of -3.9%. Reporting season is often a volatile period and this reporting season was also interesting. On a net basis, profits were a little lower than expectations (revisions of <5%) though not as poor as feared.

Companies such as Super Retail Group, Baby Bunting Group, Bapcor and Nick Scali all had solid jumps after posting their profit results.

Trailing P/E Ratio was at 198x at the end of the month, P/BV is at 2.1x and equity yield (dividend) of 3.1%.

International Shares (MSCI World ex Australia Index, Net AUD and the MSCI World ex Australia Index, Net LCL)

The MSCI World ex Australia Index (Unhedged) +0.3% for August whilst the MSCI World ex Australia Index (Hedged) returned -1.9%.

US equity market: US equity market losses were led lower by the energy sector with oil prices falling to their lowest levels in a month and a half amid growing concerns that US-China tensions would weaken demand for crude oil. Financial stocks were also impacted by increasing trade tensions which drove the demand for so-called ‘safe-haven’ assets.

UK and European markets:  Also fell sharply at the beginning of the month, spooked by a reignition of US trade war rhetoric and the inversion of the US and UK yield curves. This relatively rare phenomenon was last seen in the UK in 2008 and means that it is cheaper for the government to borrow money, or sell bonds, over ten-years than it is on a shorter basis.

Chinese equities: Underperformed as the re-escalation in trade tensions with the US impacted market performance and further highlighted the difficulty in attempting to predict the outcome of ongoing discussions between the two sides. Domestically, monthly economic indicators were broadly weaker, with industrial production slowing to a more-than-expected 4.8% year-on-year in July while fixed asset investment rose 5.7% over the first seven months of the year.

Growth stocks continue to outperform. For the month of August, the MSCI World ex Australia Growth Index (hedged) returned -0.9% versus the equivalent Value index (Hedged) of -3.0%.

At the country level, US stocks in August were marginally up +0.5% (Hedged) Other major share markets were negative on a hedged basis; Japan (-3.2%), China (-0.4%%) and Europe (-1.7%).

The index finished trading at a P/BV of 2.3x and a P/E Ratio of 17.9x and equity yield (dividend) 2.4%.

Emerging Markets Shares (MSCI Emerging Markets Index, Net AUD)

Emerging equity markets were spooked that the US economy might be headed towards a recession following an inversion of the US yield curve – this is where short-dated US Treasury bonds of two years’ maturity pay more than long-term ones of ten years’ duration. In a search for perceived ‘safe havens’, investors opted for government bonds and precious metals, such as gold and silver, over equities during August.

Emerging market shares (Unhedged) fell by -2.7% in August. But returned -2.5% on a hedged basis.

The index ended trading at a forward P/E Ratio of 13.3x and P/BV of 1.3x and equity yield (dividend) 2.9%.

Australian Listed Property (S&P/ASX 200 A-REIT Accumulation Index)

The ASX 200 AREIT index had another strong month, +1.2% in August. The theory of “lower for longer” Interest Rates has flowed through to lower Yields is one that continues to permeate throughout the markets in order to justify a number of Property transactions on all-time low Cap Rates.

At the end of August, the index was trading on a dividend yield of 4.2% with a P/BV 1.2x and a P/E Ratio 14.6x.

International Listed Property (FTSE EPRA/NAREIT Developed ex-Australia Index, AUD)

Globally REITs were marginally positive +4.5% for the month. Hong Kong REITs were negatively impacted due to investor sentiment emanating from the continued protests. US and Continental Europe were also dragged own especially in the regional mall sector. However positive returns came from Data centre and Healthcare sectors.

At the end of August, the index was trading on a dividend yield of 3.8% with a P/B 1.7x and a P/E Ratio 20.7x.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of +2.0% over the June 2019 quarter. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties range are 5.2%, 5.8% and 5.2% respectively.

Australian Fixed Interest (Bloomberg AusBond Composite Bond Index)

Australian fixed interest rose by +1.512% over the month. Australian government 10-year bond yields fell by 30bps to 0.89% while 3-year single A corporate credit spreads widened from 0.861% to 0.873%.

International Fixed Interest (Barclays Global Aggregate TR Bond Index, Hedged to AUD)

International fixed interest returned +2.32% over the month (Barclays). The 10-year US government bond yield plummeted by 50bps to 1.51% while the US corporate investment-grade credit spread widened from 1.47% to 1.62%.

Australian Economy

The month of July kicked off with another interest rate cut. The Reserve Bank (RBA) cut interest rates to a historic 1%, as it stares down the twin issues of rising unemployment and a slowing economy. This 0.25% cut followed a move at June’s meeting and is the first back-to-back cut since 2012 amid fears of a global financial melt-down flowing from European banks. The RBA’s decision was largely expected, with market pricing roughly 80% chance of a cut ahead of the RBA board meeting.

The odds of another cut had been shortening since RBA governor Philip Lowe told the market in June that one cut was unlikely to deliver the fall in unemployment the bank is looking for. The RBA has recently indicated it views a 4.5% jobless rate as close to full employment. Unemployment has been steadily rising in recent months, from a trough of 4.9% earlier in the year, and stood at 5.2% in May, while GDP growth has fallen to just 2%— the weakest reading since the immediate aftermath of the global financial crisis 10 years ago.

Many analysts expect those record low rates to get even lower, with markets pricing in a better that 50% chance of rates being cut again in November.

With the RBA cutting the cash rate another 0.25% to 1.00%, we expect an impact in this half. Housing should clearly benefit, as will business. The banks now have little excuse not to grow their lending books. The August reporting season will reflect the poor first half due to credit being tight (exacerbated by the Hayne Royal Commission), elections and trade issues. Those headwinds are largely behind us. We are cautiously optimistic about improving conditions in the final quarter this year.

The Australian Dollar weakened 2.5% against the US dollar at the end of July to 0.6848 USD from 0.7022 USD, following the interest rate cut in Australia.

Global Economy

With interest rates being cut in various parts of the world, equities were boosted on relative valuation and higher risk premium (as well as positive US earnings season providing some support). The Dow Jones rose a modest +1.0% and the Nasdaq +2.1% given its tech bias. A dash of political certainty saw the UK FTSE up +3.0% but Asian markets were mixed with the Nikkei up +2.0%. Hong Kong, with its demonstrations, eased +1.6% and Chinese equities down close to 3%. While gold was marginally higher, our lower currency meant the received price for our mining companies reached record levels – and their share prices reacted accordingly. Other metals and commodities were reasonably flat on the month.

UK: Markit’s UK manufacturing purchasing managers’ index (PMI) slipped to 48.0 in June, from 49.4 in May. Meanwhile the services PMI fell to 50.2, close to the 50 level which separates contraction from expansion, stoking fears of a further loss of momentum in the economy’s dominant consumer-exposed sector. On a positive note, retail sales rebounded in June, defying expectations for another month-on-month decline.

US: A positive start to the second quarter earnings season buoyed relative US performance. The Federal Reserve (Fed) acted late in the month to cut interest rates by 25 basis points, but Fed chair Jerome Powell said the cut is “not the beginning of a long series of rate cuts”. Investors expecting greater commitment to policy slack were disappointed. Risk appetites dwindled and the US dollar rallied.

The US economy remains on a path of waning growth. Real GDP (which is adjusted for inflation) rose at an annual rate of 2.1% in Q2, a significant slowdown from the 3.1% growth rate recorded in Q1.

China: Economic data was mixed; second quarter GDP growth came in at 6.2% compared to 6.4% in the previous quarter as trade war woes added to existing domestic pressures.  The figure still remains within the government’s full-year target of 6-6.5%. June figures were more positive with industrial production and retail sales beating expectations, and while the manufacturing purchasing mangers’ index (indicates performance of manufacturing sector) edged up to 49.7 from 49.4, it remained below 50, indicating contraction.

Europe: Data showed the eurozone economy expanded by just 0.2% in Q2, slowing from a growth rate of 0.4% in Q1. Annual inflation dropped to 1.1% in July from 1.3% in June. The European Central Bank (ECB) indicated that it was drawing up plans to stimulate the economy given the weak growth and below-target inflation. A package of stimulus measures, including possible rate cuts, is expected to be announced in September. Christine Lagarde, currently head of the International Monetary Fund, was nominated to replace Mario Draghi as president of the ECB when his term ends on 31 October.

Emerging Markets: Emerging market equities fell back in July. South Korea was weak due to a trade dispute with Japan and India underperformed following a disappointing Union Budget announcement.  President Trump’s criticism of the country’s special status at the World Trade Organisation (WTO) also exacerbated ongoing concerns over trade and global growth.

In conclusion, after their strong gains so far this year share markets are at risk of a short-term correction – with the escalating US/China trade war, along with Middle East tensions and mixed economic data providing possible triggers as we enter a seasonally weak part of the year for shares. However, valuations are fine, particularly against low bond yields, global growth indicators are expected to improve, and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12-month horizon.

Table 1: Market Performance – Periods to 31 July 2019

Sector 1 Month
%
3 Months
%
1 Year
%
3 Years
% pa
5 Years
% pa
Australian Shares 2.9 8.6 13.3 11.7 8.5
Australian Shares Small Cap 4.5 4.1 7.6 9.3 9.2
International Shares Ex-Aus (Unhedged) 2.3 2.9 11.7 14.1 13.8
International Shares Ex-Aus (Hedged) 1.2 0.9 4.5 10.9 8.7
Emerging Markets (Unhedged) 0.6 -3.3 -0.8 9.2 5.3
Emerging Markets (Hedged) -1.0 -0.6 5.5 12.0 8.1
Australian Listed Property 2.6 9.5 21.2 7.2 13.1
International Listed Property ($A) 2.2 3.8 11.8 5.9 11.4
Australian Direct Property* 1.1 8.0 11.4 11.8
Australian Fixed Interest 1.0 3.7 10.4 4.2 5.1
International Fixed Interest (Hedged) 0.7 3.4 11.8 4.3 5.6
Cash (BAUBIL) 0.1 0.4 1.9 1.8 2.1
Change over the month
Australian Govt. 10 yr Bond Yield 1.19% -14 bps
AUD/USD $0.68 -$0.02

*as at 30 June 2019

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

The S&P/ASX 200 Accumulation Index started the new financial year with a positive +2.9% for July 2019.  outperforming key international markets including the S&P 500 Index (+5.6%) and the broader MSCI World Ex-Australia Index (Unhedged) (+2.3%).

The best performing sectors in the S&P/ASX 200 Accumulation Index for the month of July were Consumer Staples (+9.8%), Small Resources (+7.9%), Health Care (+5.9%) and Information Technology (+5.0%). The worst performing sectors included Materials (+1.0%), Energy+1.7%), Financials (+1.7%) and Utilities (+1.9%).

The index finished trading at a P/BV of 2.2x and a P/E Ratio of 18.1x and equity yield (dividend) of 3.9%.

The VIX was at 13.0 (the average since 01.10.2010 is 16.4) indicating below average level of market volatility.

Australian Shares Small Cap (S&P/ASX Small Ordinaries Index)

Small Ords Accumulation Index surged in July, rising +4.5% and outperforming the broader Australian index by +1.6%. This was driven by a recovery in resource companies and lower rates driving increased equity valuations more generally.  Small resources were up +7.9% (largely driven by gold stocks).

Trailing P/E Ratio was at 19.5x at the end of the month, P/BV is at 2.3x and equity yield (dividend) of 3.0%.

International Shares (MSCI World ex Australia Index, Net AUD and the MSCI World ex Australia Index, Net LCL)

The MSCI World ex Australia Index (Unhedged) +2.3% for July whilst the MSCI World ex Australia Index (Hedged) returned +1.2%.

US equity market: US shares rose modestly in July (S&P 500 Index +1.5%) and outperformed other major stock markets. Investors broadly moved into perceived safe havens such as US Treasuries as trade tensions continue to cloud the outlook for investors and companies alike

UK markets:  The UK was one of the best performing major stock markets over July, in local currency terms. Sterling fell sharply as a result of increased Brexit uncertainty which provided a boost for overseas earners at the top end of the market. Merger and acquisition activity were also supportive.

European equity markets: Eurozone shares were virtually flat in July with the MSCI Europe Index returning 0.7%. Top gaining sectors included information technology and consumer staples, boosted by strong Q2 results from companies including Nokia and Danone. Energy and financials were among those that declined. Deutsche Bank reported its largest quarterly loss since 2015 and announced 18,000 job cuts as part of a restructuring plan.

Chinese equities: Eked out a return +0.7% for the month of July, even though US trade restrictions are starting to bite.  China’s economic growth rate has been in long-term secular decline as the government seeks to rebalance the economy to be more sustainable. Opportunities exist due to the characteristics of the Chinese markets. Chinese equities have an attractive revenue, earnings and cashflow growth profile.  Economic growth is shifting from investment-heavy industries to more sustainable and shareholder-friendly, consumer-orientated areas. Despite these advantages, Chinese equities still trade at a large discount to developed market equities and international investment communities remain underweight. maintain

Growth stocks continue to outperform. For the month of July, the MSCI World ex Australia Growth Index (hedged) returned +1.7% versus the equivalent Value index (Hedged) of +0.5%.

At the country level, US stocks produced another solid month in July, up +3.5% (Hedged) propelled by expected cut in interest rates and better than expected corporate earnings. Major share markets were again positive in July; Japan (+0.9%), China (+0.7%) and Europe (+0.7%).

The index finished trading at a P/BV of 2.3x and a P/E Ratio of 18.3x and equity yield (dividend) 2.3%.

Emerging Markets Shares (MSCI Emerging Markets Index, Net AUD)

Emerging market shares (Unhedged) rose marginally by +0.6% in July, faced by the headwind of a stronger US dollar. South Korea was weak due to a trade dispute with Japan and India underperformed following a disappointing Union Budget announcement.  But returned -1.0% on a hedged basis

The index ended trading at a forward P/E Ratio of 15.9x and P/BV of 1.3x and equity yield (dividend) 2.8%.

Australian Listed Property (S&P/ASX 200 A-REIT Accumulation Index)

The ASX 200 AREIT index had another strong month, +2.6% in July. The best A-REIT performers over the month were Stockland which delivered +9.6% and Aventus Retail Property Fund which returned +7.9%. The worst A-RET performers over the month were National Storage REIT -6.3% and Goodman Group -1.5%.

At the end of July, the index was trading on a dividend yield of 4.2% with a P/B 1.2x and a P/E Ratio 11.5x.

International Listed Property (FTSE EPRA/NAREIT Developed ex-Australia Index, AUD)

Globally REITs were up +2.2% for the month. Industrial REITs globally had another strong month.  Conversely shopping centre continue to suffer after an onslaught of disappointing retailer earnings and further announced store closures. Australian and Japanese REITs performed particularly well as did German residential stocks.

At the end of July, the index was trading on a dividend yield of 3.8% with a P/B 1.7x and a P/E Ratio 19.4x.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of +1.1% over the June 2019 quarter. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties range between 4.5% – 6.8%.

Australian Fixed Interest (Bloomberg AusBond Composite Bond Index)

Australian fixed interest rose by +0.95% over the month. Australian government 10-year bond yields fell by 14bps to 1.19% while 3-year single A corporate credit spreads tightened from 0.879% to 0.861%.

International Fixed Interest (Barclays Global Aggregate TR Bond Index, Hedged to AUD)

International fixed interest returned +0.73% over the month (Barclays). The 10-year US government bond yield remained unchanged at 2.01% while the US corporate investment-grade credit spread tightened from 1.55% to 1.47%.

Australian Economy

Australian credit data for May showed a further slowing in credit growth to its weakest since 2013 with growth in lending to property investors remaining stalled and at its weakest on record, as is growth in total housing credit. Personal credit growth is at its weakest since the GFC. Clearly the combination of tight lending conditions and reduced demand for debt continue to impact, consistent with slowing economic growth overall.

In other data, new interest-only loans provided in the March quarter fell to a new low of just 14.9% of new home loans, which is well down from their 2015 high of 46%.Similarly the total stock of outstanding interest-only loans, as share of all outstanding housing loans, has fallen to 23%, which is down from a record high of nearly 40% in 2015. Clearly interest-only loans remain out of favour, despite the relaxation of the 30% limit on loans going to interest-only borrowers in December. With interest returning to the Sydney and Melbourne property markets, it’s likely interest-only loans may soon bottom-out but given tougher lending standards it is doubtful they will return to anything like the 40% share of total loans seen a few years ago.

The RBA made the decision to cut interest rates by 0.25% to 1.25% in June, the first cut since August 2016. The RBA is concerned that unemployment is too high. It would like to reduce unemployment in order to stimulate wages growth and inflation.  The June cut Is unlikely on its own to achieve that objective.

RBA Governor Lowe’s often-repeated request for more fiscal stimulus and structural reform looks to being heeded to some degree. Infrastructure spending is continuing a pace and the Federal Government has noted it was looking at trying to bring some of it forward and, in the last week PM Morrison flagged a new focus on reducing business regulation and to take a fresh look at improving the industrial relations system. Confirmation with May data that the budget could be in surplus for 2018-19 – a year ahead of schedule – helps provide more room for additional fiscal stimulus.

The Australian Dollar weakened further against the US dollar in June, on expectations of another interest rate cut in Australia in July.

Global Economy

Optimism guided global equity markets in June was fuelled by the prospect of interest rate cuts by central banks globally and hope that the US-China trade war could still be resolved. Rebounding from a rout in May, markets shrugged off concerns about a slowing global economy to focus instead on the prospect of interest rate cuts around the world.

UK: The latest snapshot revealed subdued activity in the sector forming the backbone of the British economy, which includes finance, transport and telecommunications, in a survey of 650 services firms that is closely monitored by the Treasury and the Bank of England. The service sector accounts for about four-fifths of the UK economy. Official growth figures for the second quarter will be released in July. However, the respected National Institute of Economic and Social Research (NIESR) thinktank has forecast that GDP contracted by 0.2% in the second quarter.

US: US economic data was mixed. Pending home sales rose but new home sales fell sharply. While underlying durable goods orders rose. The slump in Boeing orders weighed on headline orders. Regional business surveys continued to weaken, highlighting the negative impact from the trade war. Personal spending rose solidly in May, but consumer confidence fell to 2017 levels with consumers less optimistic on the jobs market. This is likely concerning President Trump – sounding tough on trade may appeal to his base but if it starts to affect consumer confidence and the jobs market it won’t be good for his re-election prospects. Meanwhile, core personal consumption deflator inflation remained soft at 1.6% year-on-year.

China: Softer economic data emanating from China thanks to China’s response to stockpile ahead of higher US tariffs leading to flat Chinese manufacturing. The decline in exports and domestic activity has led to estimates for GDP growth to be adjusted down from 6.4% for 2019 and 6% for 2020. It is estimated that further tariffs could reduce GDP by 1% and employment by 4 million.

Europe: Eurozone economic sentiment fell in June and core inflation was just 1.1% year-on-year, leaving the ECB on track for more easing. Europe needs fiscal stimulus. Italy wants to do it but can’t, Germany can do it but doesn’t want to.

Emerging Markets: Emerging market shares lagged their developed market counterparts but still delivered a positive return (+4.9%). Trade uncertainty weighed on Chinese and South Korean stocks. South Africa, Indonesia, Turkey and Argentina were the best performing countries.

In conclusion, the threats around trade and geopolitical risks along with the tendency for seasonal weakness out to September/October could see a pull-back in share markets and returns are likely to be constrained. However, the availability of easy money and the absence of large-scale economic excess should help extend the cycle and keep returns for a diversified portfolio positive territory, expected return of around 6% for the year to 30 June 2020.

Table 1: Market Performance – Periods to 30 June 2019

Sector 1 Month
%
3 Months
%
1 Year
%
3 Years
% pa
5 Years
% pa
Australian Shares 3.7 8.0 11.5 12.9 8.9
Australian Shares Small Cap 0.9 3.7 1.9 10.7 9.3
International Shares Ex-Aus (Unhedged) 5.3 5.2 11.9 14.0 13.2
International Shares Ex-Aus (Hedged) 6.0 3.5 6.6 12.0 8.2
Emerging Markets (Unhedged) 4.6 0.2 1.8 11.1 6.1
Emerging Markets (Hedged) 4.9 1.8 6.6 12.9 8.7
Australian Listed Property 4.2 4.1 19.3 8.1 13.6
International Listed Property ($A) 0.2 0.8 9.6 6.1 11.3
Australian Direct Property 1.1 1.7 7.8 11.1 11.8
Australian Fixed Interest 1.0 3.0 9.6 3.8 4.8
International Fixed Interest (Hedged) 1.3 2.7 11.0 4.3 5.6
Cash (BAUBIL) 0.1 0.4 2.0 1.9 2.1
Change over the month
Australian Govt. 10 yr Bond Yield 1.38% -27 bps
AUD/USD $0.70 $0.01

*as at 31 March 2019

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

The S&P/ASX 200 Accumulation Index returned a healthy +3.7% in June but underperforming key international markets including the S&P 500 Index (+5.6%) and the broader MSCI World Ex-Australia Index (Unhedged) (+5.3%).  n the 20 June, the S&P/ASX 200 Accumulation Index closed at just 2% below its November 2007 peak.

The best performing sectors in the S&P/ASX 200 Accumulation Index for the month of June were Resources (+9.4%), Materials (+6.4%), Industrials (+5.4%) and Health Care (+4.2%). The worst performing sectors included Consumer Discretionary (-1.5%), Small Industrials (+0.4%), and Information Technology (+1.0%).

The index finished trading at a P/BV of 2.1x and a P/E Ratio of 17.5x and equity yield (dividend) of 4.0%.

The VIX was at 13.0 (the average since 01.10.2010 is 16.4) indicating below average level of market volatility.

Australian Shares Small Cap (S&P/ASX Small Ordinaries Index)

Small Ords Accumulation Index rose by +0.9%% in June again underperforming the broader Australian index by -2.8%. Within the Small Ords index, Small Resources bounced back returning +2.9% against Small Industrials +0.4%.

Trailing P/E Ratio was at 18.5x at the end of the month, P/BV is at 2.2x and equity yield (dividend) of 3.0%.

International Shares (MSCI World ex Australia Index, Net AUD and the MSCI World ex Australia Index, Net LCL)

Global equity markets, ahead of the highly anticipated US-China presidential meeting at the G20 gathering in Osaka hopes were high for a breakthrough in the trade war. A decision at the end of the month to resume trade talks after a six-week stalemate was set to further support global economic growth.

US equity market was led higher by materials, energy and tech stocks. It was a reversal of fortune for the materials sector, supported by gold prices that hit six-year highs on the back of a weakening US dollar and heightened geopolitical tensions earlier in the month. The price of oil fuelled the share prices of energy stocks as US inventories dipped and exports hit a record high, while an incident involving oil tankers in the Gulf of Oman sent oil prices climbing higher. Utilities, real estate, consumer staples and health care – all traditionally defensive stocks and less sensitive to the business cycle – were the laggards during a month in which optimism reigned.

UK markets recovered most of the ground lost during a volatile May, to end the two-month period broadly flat, soothed by an improving outlook for global economic growth, the prospect of improved US-Sino trade relations and a more accommodative tone (by leaving interest rates unchanged) from central banks including the US Federal Reserve.

European equity markets made strong gains in June as investors remained hopeful that Trump and Xi would move closer to a trade deal at the G20 summit. At a sector level, Consumer Discretionary, Materials and Industrials were the biggest gainers, whilst only one sector, Real Estate, returned negatively. Meanwhile, in his latest speech, ECB President Mario Draghi suggested that the Central Bank will further loosen monetary policy (to stimulate economic growth) unless they see an improvement in economic data.

Chinese equities gained on positive trade news flow while the central government indicated its ongoing support for the domestic market. The People’s Bank of China stated that it injected approximately US$108bn into the market in June to maintain liquidity in the banking system at a “reasonably sufficient level” while the Ministry of Finance issued new measures aimed at speeding up infrastructure spending. Macroeconomic data was mixed, with the purchasing managers’ index (PMI) – a figure that represents current and future business conditions, in June flat with the previous month at 49.4 while May retail sales were up 2.1% month-on-month.

Growth stocks continue to outperform. For the 12 months to June 2019 the MSCI World ex Australia Growth Index (hedged) returned +6.4% versus the equivalent Value index (Hedged) of +5.7%.

At the country level, US stocks rebounded in June up +7.0% (Hedged) fuelled by renewed hope over potential progress on the US-China trade talks at the upcoming G20 summit. Share markets were generally stronger; Japan (+2.9%), China (+5.3%) and Europe (+4.6%).

The index finished trading at a P/BV of 1.6x and a P/E Ratio of 18.3x and equity yield (dividend) 2.4%.

Despite the support of stronger iron ore prices and the outcome of the Federal Election, the Australian dollar (AUD) depreciated 1.3% against the US dollar (USD) due to the interest rate cut in June and anticipated one on July. The AUD fell -0.5% against the Japanese yen, down -0.8% against the Chinese Yuan Renminbi but up +0.9% against the Euro.

Emerging Markets Shares (MSCI Emerging Markets Index, Net AUD)

Emerging market shares rallied across the board in June with confidence boosted by growing expectations that central banks across several countries, including US and China, stand ready to lower interest rates on global growth concerns. For the month of June, the index returned +4.6%(Unhedged).

The index ended trading at a forward P/E Ratio of 12.9x and P/BV of 1.6x and equity yield (dividend) 2.7%.

Australian Listed Property (S&P/ASX 200 A-REIT Accumulation Index)

The ASX 200 AREIT index was up +4.2% in June. Office and industrial property sectors continue to benefit from strong leasing and transactional conditions. Larger listed property stocks were the standout performers such as; Mirvac, Goodman Group, Stockland and Charter Hall.

The A-REIT sector was the best performing asset class for the year to June 2019 returning +19.3% on the back of high demand for annuity-like cashflow steams and taking advantage of historically high premiums to NTA to de-leverage.

The A-REIT sector was trading at a 44% premium to NTA (index weight approach). While the FY19 yield for the sector is 4.7%, above 10-year bonds (1.33%).

International Listed Property (FTSE EPRA/NAREIT Developed ex-Australia Index, AUD)

Globally REITs were up +0.2% for the month. Large cap REITs significantly outperformed their smaller peers. Regionally Singapore was the strongest performer delivering +9.0% in local currency terms.  The poorest was Continental Europe, returning -3.5% in local currency terms.

At the end of June, the index was trading on a dividend yield of 3.9% with a P/B 1.7x and a P/E Ratio 19.5x.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of +1.1% over the June 2019 quarter. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties range between 4.5% – 6.8%.

Australian Fixed Interest (Bloomberg AusBond Composite Bond Index)

Australian fixed interest rose by +1.00% over the month. Australian government 10-year bond yields fell by 14bps to 1.33% while 3-year single A corporate credit spreads contracted from 0.904% to 0.879%.

International Fixed Interest (Barclays Global Aggregate TR Bond Index, Hedged to AUD)

International fixed interest returned +1.38% over the month (Barclays). The 10-year US government bond fell by 12bps to 2.01% while the US corporate investment-grade credit spread tightened from 1.71% to 1.55%.

Australian Economy

Australian data was generally soft over the month of May with a further fall in building approvals, broad based declines in business investment and continuing soft credit growth. There was some good news though with rising business investment plans for 2019-20 as the mining investment bust bottoms out and turns up and as non-mining investment continues to head up. Weak demand growth in the economy will probably mean that it won’t be anywhere near as strong.

The minimum wage is set to rise 3% from July 2019 but less than last year’s 3.5% rise.It is estimated with around 20% of the workforce (those on awards) receiving the minimum wage rise, this actually implies a 0.1% pa fall in overall wages growth over the year ahead (i.e. from 2.3% year on year down to around 2.2% yoy) all else equal. Expect wages growth to remain soft.

The combination of slower growth in the minimum wage, falling building approvals, soft credit growth, falling March quarter investment and likely only modestly rising capex in 2019-20 leave the RBA on track to continue to cut rates.

On the data front March quarter GDP data showed continuing weak growth of 0.5% quarter on quarter or 1.8% year on year due to weak consumer spending and investment and falling housing construction. In other data, a further moderation in monthly house prices falls to -0.3% month on month in CoreLogic data for May helped by a post-election bounce as property tax uncertainty was removed.

The Australian Dollar weakened against the US dollar in May, on expectations of an interest cut in Australia.

Global Economy

Global stock markets fell in May across all major regions. Investor nervousness over the outlook for global growth grew as US-China trade tensions ratcheted up. Government bond yields fell markedly (i.e. prices rose) amid a move towards perceived safe havens.

UK: Brexit uncertainty, and fears of a disorderly exit from the EU were not soothed after Prime Minister Theresa May announced her resignation following a revolt within her own party. Despite the political uncertainties, the preliminary Q1 GDP release from the Office for National Statistics revealed the economy expanded 0.5%, in line with expectations. In its latest quarterly inflation report the Bank of England upwardly revised its 2019 growth forecast, from 1.2% to 1.5%.

US: US consumer confidence rebounded in May and remains solid highlighting that while the trade war is impacting business confidence it’s not yet having much impact on consumers. In particular, consumer perceptions of the jobs market remain very strong which is consistent with jobless claims remaining ultra-low. Consistent with this, April data for personal spending was solid. Meanwhile, housing data remains mixed with pending home sales down in April and flat on a year ago and house price growth slowing but lower mortgage rates should help.

US core private consumption deflator inflation remains soft at 1.6% year-on-year and Fed Vice Chair Clarida has noted that while the US economy is in a “good place” an increase in downside risks to growth and inflation could drive rate cuts. Unless the trade war is resolved soon, Fed rate cuts are looking likely.

China: China’s composite business conditions PMI was little changed in May at a reasonable 53.3 attributable to resilient non-manufacturing conditions. However a fall back in the manufacturing PMI, probably not helped by the renewed trade threat, will maintain pressure for more policy stimulus in China.

Europe: Eurozone data in May was somewhat mixed. The flash manufacturing PMI fell to 47.7, indicating contraction, while the employment component also dipped below 50. There were some positive signs in the data, though. The new export orders component, while still below 50, did tick higher, and eurozone consumer confidence picked up in May to its highest level this year. The concern in Europe, much like the US, is that trade uncertainty filters through to the labour market and starts to hurt the service sector, which has so far proved more resilient. The latest employment growth numbers in Europe have been solid, though. The first estimates of employment growth for Q1 show a pickup to 1.4% quarter on quarter, annualised.

Emerging Markets: Emerging market equities fell in May as US-China trade talks unexpectedly broke down, and global growth concerns increased. Separately, the US announced plans for a 5% levy on Mexican imports. The MSCI Emerging Markets Index declined by -5.8% and underperformed the MSCI World by 1.4% However, Russia posted a solid gain, benefitting from a strong rally in state-controlled oil company Gazprom. Brazil and India also outperformed. India registered a small gain as Prime Minister Modi’s Bharatiya Janata Party was re-elected with a stronger mandate.

In conclusion, the calm market environment was disturbed in May, with politics again taking centre stage. Investors will be watching how trade negotiations develop, with a close eye on the G20 summit at the end of June. Beyond politics, investors should remember to focus on the economic fundamentals. China is aiming to steady the ship with its stimulus, and success here could provide a tailwind for growth elsewhere in the world.

Table 1: Market Performance – Periods to 31 May 2019

Sector 3 Months
%
1 Year
%
3 Years
% pa
5 Years
% pa
Australian Shares 4.9 11.1 10.6 7.7
International Shares ($A) 1.4 8.8 10.6 12.2
Emerging Market Shares ($A) -1.9 0.1 11.9 8.4
Australian Listed Property 6.1 17.0 7.9 13.4
International Listed Property ($A) 0.8 13.9 6.3 11.2
Australian Direct Property 1.1 8.0 11.4 11.8
Australian Fixed Interest 3.8 9.0 3.6 4.8
International Fixed Interest (Hedged) 3.1 9.8 4.6 5.4
Cash (BAUBIL) 0.5 2.0 1.9 2.1
Change over the quarter
Australian Govt. 10 yr Bond Yield 1.65% -48 bps
AUD/USD $0.69 -$0.02

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

The S&P/ASX 200 Accumulation Index returned +1.7% in May outperforming key international markets including the S&P 500 Index (-6.6%) and the MSCI World Ex-Australia Index (-4.4%).  While the global markets were dominated by escalating trade war developments, the Australian market responded positively to several factors including the unexpected federal election result where the incumbent Coalition party was re-elected with a majority, news that APRA is considering relaxing lending standards for mortgage serviceability assessments and the continued strength in Iron Ore prices.

The best performing sectors in the S&P/ASX 200 Accumulation Index for the month were Media & Entertainment (+8.0%), Telecommunications Services (+7.1%), Real Estate Management & Development (+6.4%), Banks (+5.3%) and Health Care Equipment & Services (+3.4%).  The worst performing sectors included Consumer Durables & Apparel (-12.3%), Capital Goods (-10.9%), Food Beverage & Tobacco (-9.1%), Diversified Financials (-5.8%) and Software $ Services (-4.0%).

Top performing stocks in May included Lynas Corporation (+54.0%) after China threatened to halt rare earth exports to the US, Domain Holding (+210.9%) post Federal election result, and Evolution Mining (+21.3%) supported by the strength in the gold price.

The index finished trading at a P/BV of 2.1x and a P/E Ratio of 16.5x and equity yield (dividend) 4.2%.

Small Ords Accumulation Index fell by -1.3% in May underperforming the broader Australian index by 3.0%.  Small resources marginally outperformed their industrial peers led again by performance from gold and iron ore companies. The recovery after the surprising federal election result benefitted the large cap end of the market more so than the smalls, driven by a substantial rally in banks.

Trailing P/E Ratio was at 16.7x at the end of the month and equalling the long-term average of 16.7x. The forward P/E Ratio is at 18.1x, P/BV is at 2.1x. The VIX was at 12.5 (the average since 01.10.2010 is 16.4) indicating below average level of market volatility.

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

Global equity markets sold off nearly -5.9% in May, their worst monthly decline since last December. Trade tensions raised investor fears as President Donald Trump’s newly enacted tariffs and potential expansion to other countries including Mexico and Australia threatened to further slow global economic growth. Coupled with disappointing economic data, fear also spread into the bond market as global yields fell with the US yield curve inverting and German Bund 10-year yield falling into negative territory, a new all-time low. Gold prices spiked at month-end with the increased global tensions, while oil along with other commodities sold off.

Political events also added to market unease as UK Prime Minister Theresa May’s resignation, and elections in Denmark, France, and Italy pointed toward increased nationalism. The US dollar strengthened during the month as investors sought its safety. With the single exception of Australia, every developed market fell in May with the United States and Germany leading the decline in the major equity markets.  As we entered May, the S&P 500 was at an all-time high. However, just six days into the month, investors were tested by the announcement that the US would be moving ahead with tariff increases on US imports from China. Equity markets performed poorly over the month, with Asia ex-Japan, emerging markets and the S&P 500 all losing more than 6%.

Growth continues to outperform. For the 12 months to May 2019 the MSCI World ex Australia Growth Index (hedged) returned -5.4% versus the equivalent Value index of -6.4%.

At the country level, US stocks retreated from their recent highs in May down -4.9%. Share markets were also weaker in Japan (-2.4%), China (-6.7%), Europe (-4.5%) and the UK (-6.2%). The New Zealand market bucked the global trend, with stocks there rising in the wake of the Reserve Bank of New Zealand’s decision to cut interest rates

The index finished trading at a P/BV of 2.2x and a P/E Ratio of 17.1x and equity yield (dividend) 2.5%.

The Australian dollar (AUD) was weaker in May, falling to levels not seen since early 2016. The local unit was impacted by the escalation in US-China trade tensions, rising domestic rate cut expectations and an increase in the unemployment rate. Also weighing on the currency were some mixed earnings updates and weaker commodity prices; though iron ore was a notable exception.

The AUD fell 4.0% against the Japanese yen, 1.7% against the US dollar (USD) and 1.3% against the euro. It rose 0.8% against the British pound, while the broader Australian Trade-Weighted Index1 closed the month 0.8% lower.

Emerging market shares suffered in May, returning -5.8%. The index ended trading at a forward P/E Ratio of 12.6x and P/BV of 1.6x and equity yield (dividend) 2.7%.

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

The ASX 200 AREIT index was up +2.5% in May, reacting positively to the prospects of lower interest rates and the subsequent tightening in Bond Yields, along with the proposed, less onerous APRA Lending Requirements, post the Federal Election result. The increased expectation of lower for longer Interest Rates has encouraged capital to seek higher returns.

The best A-REIT performers over the month were Stockland (SGP) which delivered +17.5% return and Mirvac (MGR) which delivered a return of +7.1%. The worst A-REIT performers over the month were Unibail Rodamco Westfield (URW) which delivered a -11.4% return and National Storage (NSR) which delivered a return of -6.7%.

At the end of May, the A-REIT sector was trading at a 347% premium to NTA (index weight approach). While the FY19 yield for the sector is 4.4%, above 10-year bonds (1.%).

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

Globally REITs were down -0.2% for the month, with the continued weakness led by Asia/Pac (-1.3%) with the best region the US (-0.7%). On a year rolling basis, the US REIT sector remains the best performing market (+15%) with the worst performing market being the UK (-7.6%). At the end of May the index was trading on a dividend yield of 3.9% with a P/B 1.7x and a P/E Ratio 18.6x.

Australian Direct Property (Atchison Consultants Unlisted Property Funds Index)

Australian direct property posted a return of +1.1% over the month. Capitalisation rates across property sectors continued to trend downwards. Cap rates across office, industrial and retail properties range between 4.45% – 7.0%.

Australian Fixed Interest (Bloomberg AusBond Composite Index)

Australian fixed interest rose by +1.71% over the month. Australian government 10-year bond yields fell by 33bps to 1.47% while 3-year single A corporate credit spreads contracted from 0.919% to 0.904%.

International Fixed Interest (Barclays Global Aggregate TR Bond Index, Hedged to AUD)

International fixed interest returned +1.42% over the month (Barclays). The 10-year US government bond fell by 37bps to 2.13% while the US corporate investment-grade credit spread widened from 1.50% to 1.71%.