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February Economic & Market Summary

Tuesday, March 03, 2015

How the different asset classes have fared

(as at 31 January 2015, unless otherwise stated):

Asset Class

1Mth

%

3Mths

%

6Mths

%

YTD

%

1Yr

%

3Yrs

% p.a.

5Yrs

% p.a.

10Yrs

% p.a.

Cash1

0.3

0.7

1.4

0.3

2.7

3.1

3.8

4.8

Australian Bonds

1.6

4.6

6.4

1.6

10.4

7.0

7.4

6.7

International Bonds3

2.6

5.1

7.8

2.6

12.0

7.6

8.5

7.8

Australian Shares4

3.0

1.7

0.9

3.0

11.3

13.5

8.4

7.5

International Shares Unhedged5

3.2

11.5

18.3

3.2

20.1

25.6

13.9

6.0

International Shares Hedged6

n/a

4.0

9.5

1.9

18.9

18.6

15.8

n/a

Emerging Markets Unhedged7

5.7

7.2

8.6

5.7

17.9

11.6

5.8

8.4

Listed Infrastructure Unhedged8

5.2

12.2

18.4

5.2

26.8

23.5

11.9

7.5

Australian Listed Property9

7.4

12.3

15.4

7.4

35.7

22.6

14.4

2.5

International Listed Property Unhedged10

11.0

21.8

32.5

11.0

41.7

26.8

18.6

1Bloomberg AusBond Bank 0+Y TR AUD, 2Bloomberg AusBond Composite 0+Y TR AUD, 3JPM GBI Global Ex Australia TR Hdg AUD, 4S&P/ASX All Ordinaries TR, 5MSCI World Ex Australia NR AUD, 6MSCI World ex Australia NR AUD Hedged as at 6/2/15, 7MSCI EM NR AUD, 8S&P Global Infrastructure NR AUD, 9S&P/ASX 300 AREIT TR, 10FTSE EPRA/NAREIT Global REITs NR AUD

 

Australian Economic Conditions

There is an expectation that economic growth with remain below long term averages into 2015. There are a range of contributing factors, but one of the key issues continues to be the decline in mining investment as the mining boom fades. The gap left by the decline in mining investment, however, is not being filled by non mining investment.  Business confidence (see the graph below) is reflective of this unwillingness to invest. Other  issues at play here include rising political risk where governments are seen as being unwilling or unable to adequately address structural issues in the economy and high private debt levels.    

      

Cash

The Reserve Bank of Australia (RBA) took most economists by surprise in announcing a 0.25% rate cut at its first meeting of 2015, given it had explicitly stated last year that it would be providing forward guidance as to any change in its stance. The benchmark cash rate is now 2.25%.

Australian Bonds

Australian bonds rallied along with offshore markets. Expectations of rate hikes in Australia have rapidly swung to expectations of rate cuts. It would seem unlikely the RBA has interrupted the long period of rate stability just for a ¼ of a percent cut and a follow up is widely expected at the March or April meeting. While Australian interest rates may seem low, they stand out like a sore thumb for yield hungry offshore investors. 2.5% for 10 year Australian government bonds sounds a lot better than 0.375% for equivalent German Bunds or even -0.059% for Swiss 10 years[1].

As the RBA recognised in its February meeting, Australia faces a challenging macro economic environment as the decade long mining boom fades. Looser monetary settings to help support non resource sectors of the economy take up the slack and to get the $A down in order to support the likes of the beleaguered Australian manufacturing sector would seem the order of the day.

The only thing staying the RBA’s hand has been concern over fuelling a residential property price boom. In the statement announcing the rate cut the RBA Governor, Glenn Stevens, made a nod to this. He indicated there would be the continued pursuit of the sort of measures introduced last year by APRA, the banks’ regulator, such as “likely supervisory action” if a bank’s property investment loan book grows by more than 10%. By specifically targeting housing credit these sorts of “macroprudential” policies free the RBA to cut rates to support the wider economy.       

Australian Equities

Given the economic conditions, the probability is that the Australian equity market will remain subdued. While the impact of the decline in mining investments has been well documented, financial stocks, in particular the major banks, in our opinion are coming under increased pressure. The banks are heavily exposed to the mortgage market, which is progressively made up of investors (particularly in the major capital cities). We believe that a combination of generally heavily indebted households (impacting ion credit demand) and increased regulatory control, makes the bank stocks appear expensive. 

Thus we believe an underweight position to Australian equities is appropriate in the current economic environment. Having said that we understand that many investors remain attracted to some sectors within the Australian market, given they offer strong yields, compared to other asset classes.

Listed Property

There are conflicting forces currently playing out in this sector. Supporting the Australian market is the continuing global search for yield, and solid global capital flows from foreign investors in commercial property. Opposing forces include continued soft market fundamentals as reflected in elevated vacancy rates, weak net absorption and high tenant incentives.  Overall our view is that the recent strong performance in this market is unlikely to be sustainable. As prices have rallied the yield the sector offers has fallen. For the Australian listed property market the yield is now comparable to the broader equity market.

International Economic Conditions 

As illustrated in the accompanying graph, the global economic recovery from the financial crisis of 2008 has been sluggish. Another aspect of the recovery is that it has varied between regions. In the US an enduring economic recovery appears to be under way but the recovery in the Eurozone is weak and Chinese growth has slowed. As a result falling inflation rates in many economies is causing concern with policy makers. Against this back drop we have recently witnessed a sharp fall in global oil prices, which has also exacerbated the decline in inflation. This will benefit oil importing countries over oil exporting countries, with the aggregate impact being a net benefit to global growth. We must also factor in the efforts of central banks in arresting slowing economic conditions. Whilst the US Federal Reserve is likely to reduce their stimulus this year, with the prospect of rising interest rates, the European and Japanese central banks are increasing their stimulus.  

International Bonds

Contrary to almost universal expectations, last year was a good one for bond investors and this has continued on so far this year. Bond prices move inversely to yields, so as low yields move even lower bond investors have enjoyed capital gains. In the face of the US’s central bank (the “Fed”) ending its quantitative easing program (QE) of money creation and looking to start a cycle of interest rate hikes many investors, understandably, saw bonds as more likely to be associated with capital losses than gains.

However, in a world where many economies were in aggregate saving more than they were consuming (Europe, Japan, China), excess savings continued to chase yields down.

In addition, while the US has ended its QE experiment, the rest of the world is going in the opposite direction. The European Central Bank (ECB) was the latest example of this, announcing the launch of a credible QE program. This adds to the liquidity already being injected into the system by the Bank of Japan which stepped up its already large QE program late last year.


International Shares

With the expectation that, in aggregate, modest global economic growth will continue, the question is whether current share price valuations have priced in these expectations.

Our response is that there is no simple answer to this question. For example whilst valuations in the US appear stretched, if the economic recovery can accelerate, and company earnings and profitability remain healthy, then these valuations may be sustainable for some period of time. Other regions such as the Eurozone, offer more valuation support, but face a more uncertain economic path.

With this as a back drop, we believe that selective investing in international equities provides the best opportunities in the current environment. An additional benefit is that with the prospect that further depreciation in the Australian dollar is likely, unhedged international equities will receive a currency boost.

Emerging Markets

The universe of emerging markets equities is vast and therefore can make investing in this sector particularly challengingFurthermore, as we have witnessed in recent months, the challenges facing many emerging markets can be very specific to that country and extremely damaging. Russia, for instance, has been hit by both sanctions and the decline in the oil price. In this environment selective and active investing in this sector is particularly important. One current area of focus is the Asian region where we believe the long term growth options are greatest; and where (some) governments are focused on improving the structural nature of their economies to make them more resilient to external shocks.   

Listed Infrastructure

We believe infrastructure assets possess two key benefits. A structural benefit of this asset class is that regulated and user pay assets benefit from solid, predictable earnings which results in more sustainable cash flows. Their shares prices are therefore generally less impacted by the vagaries of the equity markets. Secondly, we believe that emerging market infrastructure valuations are currently attractively priced. Whilst political interference and regulation can be one of the key risks of investing in this asset class, we believe that this risk can be reduced through a thorough assessment by fund managers that invest in this sector.        


To discuss this further or to speak with a Matrium Financial Services Adviser, contact us today on 02 8861 1840.



[1] Bloomberg


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