August 2019: Summary of Key Views
It’s a challenging time for asset allocators in the current environment, which has seen asset prices and market sentiment shift quickly on the back of a single tweet. Markets in July were generally strong across most assets, but August has seen a re-emergence of trade tensions between the US and China. More importantly we have seen the yield curve invert with the 10-year US treasury falling below the 2-year treasury for the first time since 2007, which, as you may recall from the text books, has historically been an indicator of economic weakness.
In an environment where markets can rapidly change tack it is important to have a framework to anchor your asset allocation process. We focus on asset valuations, the market’s position in the business cycle, and other factors such a liquidity and sentiment. In the current environment we continue to seek diversifying assets such as alternatives and from a bottom-up perspective we seek investments that have the mandates to perform in different market conditions. From an asset allocation perspective our main active positions remain an underweight position to Australian equities and a positive tilt to listed infrastructure and alternatives. Asset price returns in recent years have been well in excess of our long-term expectations, which has been a positive outcome for clients. We believe that the environment going forward will be more challenging with asset valuations generally within the fair to slightly expensive range and business cycle indicators trending down.
Market developments during July 2019 included:
Australian shares lifted in July on the back of improving global sentiment as trade negotiations between the US and China appeared to be heading in a positive direction and central banks stepped in to offer support to address the ongoing uncertainty. This narrative quickly fell apart at the start of August as trade negotiations again broke down, sending the ASX tumbling -4.3% over the first week. Consumer Staples (+9.8%) led the gains in July, with the China-exposed A2 Milk Co (+23.6%) and Bellamy’s (+21.5%) the major beneficiaries, although these gains were partly reversed in the first week of August with falls of -7.7% and – 10.0% respectively.
Health Care (+5.9%) was another top performer, with gains from Resmed (+10.7%) and biotech giant CSL. Expectations for aggregate FY19e EPS growth have continued to drift lower over the course of this calendar year and there has also been a stark contrast between super sector earnings outlooks with a positive pulse seen in Resources, declines off low bases for Banks, and sharper deceleration for Industrials. Uncertainty and volatility are expected to remain in global markets, with ramifications for Australian shares, as central banks continue to drive speculation surrounding additional global monetary policy support.
Global shares finished modestly higher in July but positive signs from trade negotiations and the strong expectations of rate cuts could not sustain the previous month’s momentum. The MSCI World Ex Australia Index rose 2.4% in Australian dollar terms and 1.2% in local currency terms but this was quickly reversed through early August with news that the US and China had again walked away from negotiations. In the US, the S&P 500 Index was lifted to an all-time high of 3,025 points late in the month, only to be undone by the subsequent falls in global markets. Chinese equites made only modest headway in July and remain under pressure as the US’s trade actions take their toll. Meanwhile there are reports of US corporates rejigging their supply chains to avoid the tariffs on Chinese goods, with Vietnam emerging as a potential early winner.
The US market remains the bright spot for global investors, with July seeing further gains in the key Information Technology (+3.2%) and Communications (+3.0%) sectors, although there are still concerns that valuations are stretched. Europe remains mired in disappointing economic data and persists as a deep value play. The ECB’s willingness to dole out stimulus might provide a cushion and support shares, but volatility should be expected with Brexit negotiations set to ramp up once again under Britain’s new prime minister Boris Johnson.
The rise in bonds continued through July in stark defiance of investors who called a fade to the rally in late 2018 when the US Fed appeared determined to continue along its tightening path. The US 10-year Treasury yield has dropped from a rate of 3.24% in November 2018 to 1.71% at the time of writing, while the 30-year yield has seen a similar decline, amounting to an almost 40% rise in the value of long-duration Treasury bonds. The bond market continues to track a deterioration in global growth, but so far there are few signs that more aggressive action is required by the Fed. In Australia, the 10-year Treasury yield fell from 1.32% to 1.19% over July. Looking forward, low inflation remains a key issue, as does spare capacity in the labour market. Domestic bonds have rallied significantly in recent months on the back of two RBA cuts and weakening economic data. Credit remains popular with active managers still favouring a bias to corporate bonds within portfolios, albeit bell-ended with more defensive positioning in sovereign bonds or cash-like assets. Emerging markets are an attractive option for investors seeking yields well beyond what is on offer in other developed markets, with many active managers choosing to utilise a portion of their risk budget in these types of assets.
REITs (listed property securities)
Listed property is benefiting from the hunt for yield spurred by the low rate environment, with the S&P/ASX 200 A-REIT Index gaining 2.6% in July, adding to its stellar performance over the past 12 months. Despite a beaten down retail sector there were solid gains from shopping centres, with Stockland (+9.6%) topping the leaderboard, followed by Vicinity Centres (+4.5%) and Scentre Group (+3.9%). Real asset sectors globally have benefited in calendar 2019 with expectations swinging around to lower interest rates, and in Australia the RBA having cut the official rate twice (from 1.50% to 1.00%). In this environment, the sector continues to attract capital, which is underpinning high valuations and reflecting lower yields. Nonetheless, fundamentals are supportive, with rental and earnings growth continuing in most sectors across the globe.
In Australia, there has been a surge in wholesale money looking to redeem from retail property funds and listed property funds are also putting non-core retail assets on the market. Meanwhile Australia’s residential housing market looks to be past the worst as prices rose nationally for the first time in June. Rising auction clearance rates and low cash rates are starting to reverse buyer sentiment, but with low supply and lending still questionable, a strong rebound in prices may be too much to hope for.
Preliminary estimates for July indicate that the index increased by 3.1 per cent (on a monthly average basis) in SDR terms, after increasing by 2.9 per cent in June (revised). The non-rural subindex increased in the month, while the rural subindex decreased and the base metals subindex was little changed. In Australian dollar terms, the index increased by 2.2 per cent in July. Over the past year, the index has increased by 16.1 per cent in SDR terms, led by higher iron ore, gold and copper ore prices. The index has increased by 21.0 per cent in Australian dollar terms.
(Source: Lonsec Research August 2019)