July 2019 Newsletter
The market is taking risks in its stride
June was a strong month for markets with most asset classes generating positive absolute returns despite global economic data generally being flat to weak depending on the region. Domestically we saw a further rate cut of 25 basis points, bringing the official cash rate to a record low of 1.00%, a clear indication that the RBA is looking to support the Australian economy. In their statement the RBA Governor noted increased risks related to trade wars contributing to slower growth in Asia, subdued consumption growth impacted by low wage growth, and declining house prices and strong employment growth. As noted in last month’s commentary, the prospect of quantitative easing (QE) is entering the conversation in a similar fashion to what we have seen in Europe and the US, whereby the RBA would buy government and corporate bonds using cash on its balance sheet, effectively flooding the market with liquidity while keeping rates low. A key consideration as to whether the RBA goes down the path of QE will be whether banks pass on the rate cuts to borrowers. While lower rates will be welcomed by mortgagees, for retirees, generating an income in retirement has become increasingly challenging. One of the potential side effects of the low rate environment is that retirees begin allocating to higher risk assets to generate yield and a real rate of return without fully understanding the additional risks they are taking on. We saw this behaviour in the years leading up to the financial crisis in 2008, with a range of products brought to market targeting retirees and promising high yields. The key is to understand what the risk are because as we know there are no free lunches. We continue to believe that we will experience more frequent bouts of market volatility. In such an environment, we believe selective valuation opportunities will increasingly present themselves for the long-term investor. As we have seen in recent years, markets have been heavily influenced by central bank policy. What is also clear is that the sentiment relating to monetary policy can change quickly, as it did in the US where the prevailing narrative of rate hikes quickly shifted to one of rates on hold. In such an environment we believe portfolio diversification remains ever important.
Market developments during June 2019* included:
Australian shares pushed higher through June on the back of improving sentiment around global trade and a rallying US market. The S&P/ASX 200 Index returned 3.7% over the month, finishing above 6,600 points and moving above 6,750 early in July, pushing closer to its 2007 record high. Gains were led by large cap shares, with miners capturing the spotlight. Materials (+6.4%) was the top gaining sector over June, including solid gains from majors Newcrest (+17.4%), Fortescue Metals (+12.1%) and BHP (+9.00%), while Galaxy Resources (-22.0%) remains plagued by a falling lithium price and short sellers. Industrials (+5.4%) had a positive month, with Sydney Airport (+8.5%) higher after announcing a rise in domestic passengers over June and has achieved a turnaround on international visitor numbers despite fears of a slowdown in Chinese visitor numbers. Ship builder Austal (+16.4%) saw a solid boost after being inducted into the ASX 200. Within the Health Care sector (+4.2%), Nanosonics (+24.9%) was the standout in June, rising to an all-time high as investors were drawn to the company’s impressive half-year results and the growth potential for its disinfection technology.
Global shares rebounded in June as central banks prepared markets for potential rate cuts and trade tensions appeared to ease following the G20 summit in late June. Developed market shares, measured by the MSCI World Ex Australia Index, rose 5.4% in Australian dollar terms and emerging market shares rose 5.0%, helped by a softer US currency. The US S&P 500 Index rose 7.1% in June in US dollar terms with all sectors positive, with large gains from the Materials (+11.5%) and Energy (+9.1%) sectors. Marathon Petroleum (+21.5%), now the largest refiner in North America after its acquisition of Andeavor, saw solid gains on the back of a rising oil market, helping to make up for disappointing margins in recent months. The Information Technology sector (+9.1%) made up ground following May’s poor performance, including a 13.1% gain from Apple, which has benefited from the trade truce. In Europe, the resources sector (+9.5%) was the top gainer among STOXX Europe 600 shares, while auto stocks (+6.7%) recovered from the trade woes of the previous month. Banks (+1.6%) were positive over June but still struggling as markets anticipate a fall in interest rates. Asian markets were higher in June as trade fears lifted (at least for now), with gains from Japan’s Nikkei 225 Index (+3.5%), Hong Kong’s Hang Seng (+6.7%) and China’s CSI 300 (+6.1%).
With bond yields at record lows in many developed markets, the rally in bonds was given a further boost by the RBA, which cut rates to 1.00% at its July meeting. Australian bonds, measured by the AusBond Composite Index, returned 1.0% over June and has returned an impressive 9.6% over the past 12 months, rivalling returns on Australian shares. The yield on Australian 10-year Treasuries fell over June from 1.46% to 1.32%, and the 90-day Bill rate fell from 1.42% to 1.21%. The story is much the same globally: while the Fed is yet to cut rates, over the course of 2019 they have pivoted away from a tightening to an easing bias. Markets fully priced in a 50-basis point cut in the funds rate at its next meeting scheduled for the end of July, however this was pared back following June’s strong jobs result. Low rates have also sparked a renewed hunt for yield, which has been reflected in the high yield segment of the bond market. ECB President Mario Draghi defended the bank’s approach to combatting slowing growth, suggesting that his successor Christine Lagarde would have the option of cutting rates or deploying additional stimulus. European yields dropped further through the month, with the German 10-year yield moving further into negative territory from -0.20% to -0.33%.
REITs (listed property securities)
Australian listed property continued its winning streak in June, returning 4.2% as yields fell and the RBA’s rate cut spurred interest in income-generating assets, including listed property. Goodman Group (+12.2% in June and +56.2% over 12 months), the largest member of the ASX A-REIT Index, has ridden the logistics wave as Amazon’s landlord, continuing its rise through June although possibly reaching expensive territory with its yield currently around 1.6%. Charter Hall Group (+4.7%) and Abacus Property Group (+7.1%) are bidding as a consortium for the Australian Unity Office Fund, making a final offer of $3.04 per share compared to its price of $2.37 at the end of June, valuing the trust at around $496 million. Charter Hall Group was the top performer over the financial year (+66.1%) and is set to deliver solid full-year results after upgrading its earnings guidance. Dragging on the index were the shopping centre REITs, including Vicinity Centres (-5.0%) and Scentre Group (+1.1%), which remain affected by the soft retail environment. In the US, REITs were mostly flat through June in US dollar terms (+0.9%), with gains from Warehouse and Industrial (+6.9%), Shopping Centres (+1.3%) and Healthcare (+1.3%), and falls from Office Property (-2.3%) and Regional Malls (-2.2%).
Preliminary estimates for June indicate that the index increased by 2.1 per cent (on a monthly average basis) in SDR terms, after increasing by 0.3 per cent in May (revised). The non-rural and rural subindices increased in the month, while the base metals subindex decreased. In Australian dollar terms, the index increased by 2.3 per cent in June. Over the past year, the index has increased by 13.0 per cent in SDR terms, led by higher iron ore, gold and beef & veal prices. The index has increased by 19.4 per cent in Australian dollar terms.
If you would like to know more about assset class performance, the market outlook or anything else in particular please contact Agility Wealth Partners on (02) 8277 4216 or email email@example.com.
*Source: Lonsec Research July 2019