We have observed over the last couple of years that market sentiment is shifting more rapidly. Earlier this year the US Federal Reserve flipped on its monetary stance from a tightening stance to a “let’s take pause and see how things pan out” position. Back in August of this year the yield curve inverted meaning that long-term bond yields were lower than short-term bond yields. The most common measure of this is the difference between 2 and 10 year government bond yields. Markets reacted negatively to this as an inverted bond yield is typically an indication that investors are concerned about the economy. It has also been a good predictor of a looming recession with an inverted yield curve preceding every US recession since the 1970s. Interestingly, the time between the yield curve inverting and a recession is highly variable and equity markets have historically performed strongly until a recession has hit. For example, in 1988 the S&P 500 rose by over 30% prior the recession and in 2006 it rose approximately 16%. The yield curve has since steepened and is no longer inverted. So does this mean that recessionary fears have abated?

From our perspective the economic news are mixed. Indicators such as manufacturing data have been trending down, however housing has been strong in the US and has improved in Australia. Consumers are also holding up in the US. Geopolitics continue to be an X-factor with news regarding US – China trade talks continually shifting, whilst the prospect of further quantitative easing is certainly plausible. From a bottom-up perspective, many of the professional investors Lonsec speaks to are indicating that they don’t expect a recession within the next 12 months but over a 2 year timeframe the risk of recession rises.

Amidst this uncertain backdrop, from an asset allocation perspective we have retained our slight defensive bias holding a greater exposure to real assets and focusing on diversification via uncorrelated assets such as alternatives.

Market developments throughout October 2019 included:

Australian Equities

Following relatively strong performance in the September quarter, the outlook appears mixed across most sectors. Australian shares were in the red in October, dragged down by the Information Technology (-3.9%) and Financials (-2.8%) sectors. Optimism among investors is being driven by monetary stimulus, signs of a recovery in the housing market, and a soft Australian dollar, which boosts earnings from foreign operations. Working in the opposite direction is sluggish wages growth, relatively weak building and construction activity, and an uncertain global outlook.

Returns for interest rate sensitive sectors (e.g. Utilities and Property) are expected to continue to be supported by the search for income and historically low bond yields. Financials remain under pressure from an industry perspective with bank profit growth expected to be moderate due to constrained lending and net interest margin pressures. IT stocks are trading at expensive valuations and look increasingly vulnerable without supportive earnings growth. Health Care (+7.6%) was the standout sector in October, with giants CSL (+9.6%) and Resmed (+7.2%) both contributing to the performance, while among the Industrials (+3.0%) Sydney Airport (+9.3%) and Seven Group (+7.7%) were among the top gainers.

Global Equities

The trade wars have weighed on business sentiment, which is taking its toll on manufacturing and export-sensitive sectors across several regions, particularly Europe, Japan and China. However, the services sector has remained relatively resilient, driven primarily by the robust US consumer sector, which is enjoying healthy balance sheets, steady employment and wage growth, and low interest rates. Emerging markets remain in the passenger seat of the ongoing trade wars, which saw emerging market equities remaining under pressure.

Export-dependent economies such as China, Taiwan and South Korea continue to feel the negative impact, which has been exacerbated by tensions between Japan and South Korea. Global developed market shares (exAustralia) gained only 0.5% in October in Australian dollar terms as the global outlook moderated. The US S&P 500 Index rose 2.2% in US dollar terms, led by the Healthcare (+5.0%) and Information Technology (+3.8%) sectors. European shares, measured by the STOXX Europe 600 Index, gained a modest 0.9%, with a bounce from the auto sector (+6.9%) and construction (+3.5%).

Fixed Interest

After a brief pause, the RBA continued its easing bias in October with a 25-basis point reduction in the cash rate to a historic low of 0.75%. The decision was taken in order to support employment and income growth, and to provide greater confidence that inflation will be consistent with its medium-term target. Australian government bond prices moved higher in September, in tandem with its US and German counterparts as risk-off sentiment dominated the past quarter. However, the trend reversed somewhat through October with demand for safe-haven assets weakening as investors flocked back to risk assets.

Australian bonds returned -0.5% in October as yields edged back up, while global bonds, measured by the Bloomberg Barclays Global Aggregate Index, fell 0.3% in Australian dollar hedged terms. Going forward it is expected that global yields will continue to remain at low levels with most central banks returning to easing mode amid sluggish growth outlook. Spreads have been gradually widening since the end of August but are still narrow, with the 10-year minus 2-year spread at around 17 basis points at the end of October.

REITs (listed property securities)

From a macro perspective, Australian real estate capital values appear to be late in the cycle, with ‘lower for longer’ monetary policies extending cycle duration. Moving forward, growth is likely to be driven by asset level net operating income growth, rather than further capitalisation rate declines. The retail landscape is experiencing a bifurcation and ‘flight to quality’, where foot traffic (and dollars) are increasingly flowing to shopping centres that are grocery anchored or have a mix of experiential retail offerings in densely populated primary trade areas.

Despite capitalisation rates falling to historic lows, the logistic and industrial sector continues to enjoy robust investor demand. The rise of e-commerce has translated into higher tenant demand for well-located warehouses, logistics and distribution centres with good transportation links and population proximity. Sentiment towards the residential sector has continued to improve on the back of the RBA’s successive interest cuts and APRA easing its credit lending guidelines, which is filtering through to prices for mainly existing houses. In the US, retail securities (especially Shopping Centres) have performed reasonably in recent months,

in line with the broader market switch to value stocks. While this is unlikely to herald a prolonged period of outperformance, it demonstrates that investors recognized that parts of the retail sector had been oversold.

Alternatives

Preliminary estimates for October indicate that the index decreased by 2.4 per cent (on a monthly average basis) in SDR terms, after decreasing by 2.9 per cent in September (revised). The non-rural subindex decreased in the month, while the rural and base metals subindices increased. In Australian dollar terms, the index decreased by 2.0 per cent in October.

Over the past year, the index has decreased by 4.2 per cent in SDR terms, led by lower coal, LNG and alumina prices. The index has decreased by 1.3 per cent in Australian dollar terms.

Please contact Agility Wealth Partners on (02) 8277 4216 or info@agilitywealth.com.au if you would like a chat about your portfolio or a general discussion about your wealth management requirements.

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