Our global economic forecasts project a contraction in world GDP (by around ½ %). This would represent the first contraction in world GDP since World War II.
In the second half of 2009, economic momentum appears to have gathered speed and the former consensus about a ‘W” shaped recovery has wavered to be replaced by those arguing the normal ‘V” shaped recovery is underway.
Despite this improved outlook central bank and government policy settings are likely to remain at extreme levels, especially in the developed world. Reluctance by governments to withdraw fiscal stimulus is being driven by widespread uncertainty about the strength of the recovery, and in particular, concerns that consumer de-leveraging (given high unemployment, weak incomes growth and structurally higher savings) and low investment will limit the strength of the recovery. This environment is termed the ‘New Normal’ by some commentators.
Active equities funds management is favoured given wide dispersion in stock and sector valuations. Quality is still preferred given balance sheet risks but this factor is lessening as an influence as companies have moved to refinance (for example, in the last financial year, listed Australian equity raisings were an estimated A$ 90 bn or around 10% of market capitalisation). In domestic equities, we advocate a neutral style bias, with a tilt toward value in the international market.
In the short-term, global inflation has fallen substantially, allowing key central banks to cut rates to near zero. It is uncertain if a deflationary environment will persist (as it has in Japan since the early 1990s) or if the massive policy easings by central banks will eventually translate into an inflation problem. A well diversified Alternatives portfolio can help to capitalise on trading strategies that exploit this uncertainty in market pricing.
Longer term, we anticipate equity returns to be relatively modest as detailed in our Strategic Asset Allocation Review (June 2008). Absolute return strategies are appropriate in these market conditions and we believe that tactical signals can be identified according to expectations about equity market trends (using beta as a simple indicator).
Despite the rally seen in credit markets, global investment grade credit remains attractive (relative to sovereign bonds) but as cumulative company default rates rise (projected to be over 15% in the high yield sector) investors need to be wary of security specific risk.
Australia is holding up well compared to other countries as its large budget surpluses have been spent, a ‘temporary’ budget deficit has been engineered, monetary policy has been eased aggressively and the economy has benefitted from its Asian trade exposure. Economic forecasts have been revised up with the economy now likely to escape recession in 2009. These factors should boost equities further in the short-term.
The Australian cash rate has been held at 3.00% by the RBA as there are signs that previous policy easings taking effect (e.g. in retail sales data and consumer confidence). The forward interest rate markets have factored in rate hikes to 4.5% by mid-2010 which seem more realistic in view of recent strong data despite rising unemployment. Nonetheless, the RBA has foreshadowed hikes are possible even while unemployment is at high levels.
Market developments during August 2009 included:
Equities
The Australian equities market recorded its sixth consecutive monthly gain in August, up 6.6% for the month. During the month, investors’ attention was fixed on reporting season, particularly over the provision of management guidance on earnings outlook. The overall results have been positive with a large percentage of companies exceeding consensus forecasts. This combined with a flow of positive economic data releases saw the market again stage a robust rally.
Under the buoyant market conditions, defensives have again lagged the broader market. Telecommunications fell -3.6% while Utilities were -3.3% weaker. And despite industrial metal prices firming during the month, Materials companies fell modestly to be down -0.5%. In comparison, Financials (including AREIT) led the market higher with a 12.8% gain. Cyclical industrials, particularly those linked to the construction sector, have also posted solid gains at 11.7%.
Similar themes have emerged in global equities with the market continuing to draw strength from the improvement in economic data in the US. The MSCI World ex-Australia Index returned 2.3% for the month, with approximately one third of the monthly gain lost due to the appreciation of the Australian dollar against other major currencies. In local currency terms, the best performing regions were Europe (5.8%) followed by North America (4.0%). Asia Pacific ex-Japan edged to a slight gain for the month (0.2%) as the broader region was kept subdued by the steep decline in the Chinese equities market.
Similar to the local market, Financials and Industrials were the best performing sectors for the month with a 4.1% and 8.9% gain respectively in local currency terms. Banks were stronger last month (11.3%, extending their year-to-date gains to 30.4%). Mining companies finished the month down -0.43%. In comparison, energy companies were stronger last month (1.9%) despite spot crude oil prices posting a moderate fall for the month.
Emerging market equities lagged developed markets with a -2.0% decline last month (in Australian dollar terms). The underperformance was heavily driven by profit taking in the Chinese equities market and investors’ concern over the impact of more restrictive monetary policy setting on economic activities. In comparison, other major emerging markets, such as Brazil, Russia, and India, all recorded positive monthly performances.
Small caps outperformed large/mid caps in global equities (5.6% vs. 3.6%) but modestly lagged in the local market (the S&P/ASX Small Ordinaries Accumulation Index returned 6.4% for the month). Australian small cap industrials recorded a 9.0% gain and significantly outperformed the resources minors (0.8%). Across global small caps, Europe was the best performer at 8.1% while North America returned a solid 2.8% gain. After the recent rally, the valuation for global small caps is increasingly stretched, trading at 23 times 12-month forward earnings.
Fixed Interest
Australian and global government bonds rose 0.8% and 1.1% respectively in August. The sector recorded a solid performance despite generally strong economic data released during the month, although it was noted that Australian government bonds may have recorded a one-off gain from the change in the interest withholding tax rule. The Australian 10-year government bond yield ended the month 19bps lower at 5.42%. The US edged lower to 3.40%, Japan fell 9bps to 1.31%, while Europe and UK 10-year government bond yields ended the month at 3.26% and 3.56% respectively.
The rally in corporate debt securities continued in August, making it the sixth consecutive month of positive gains for both investment grade and high yield corporate debt securities. The Merrill Lynch Corporate Bond (Investment Grade) Index returned 1.5% (fully hedged to the Australian dollar), and is now up 9.0% since March. The resurgence in demand for risky assets saw high yield securities post another 2.6% gain, extending the sector’s gain since March to 39.5%.
Property & Infrastructure
Australian and global government bonds rose 0.8% and 1.1% respectively in August. The sector recorded a solid performance despite generally strong economic data released during the month, although it was noted that Australian government bonds may have recorded a one-off gain from the change in the interest withholding tax rule. The Australian 10-year government bond yield ended the month 19bps lower at 5.42%. The US edged lower to 3.40%, Japan fell 9bps to 1.31%, while Europe and UK 10-year government bond yields ended the month at 3.26% and 3.56% respectively.
The rally in corporate debt securities continued in August, making it the sixth consecutive month of positive gains for both investment grade and high yield corporate debt securities. The Merrill Lynch Corporate Bond (Investment Grade) Index returned 1.5% (fully hedged to the Australian dollar), and is now up 9.0% since March. The resurgence in demand for risky assets saw high yield securities post another 2.6% gain, extending the sector’s gain since March to 39.5%.
Alternatives
Hedge funds returned 2.4% in July, further extending their positive performance since the beginning of the year. Positive performances were recorded across most strategies with short-biased equity hedge strategies (-6.5%) the standout exception. Equity Hedge and Relative Value strategies benefited from the reduced pricing anomalies in equity and credit markets, while Global Macro strategies recorded a more modest return, particularly from systematic macro managers.
Commodities posted a positive return of 3.2% last month as measured by the Dow Jones/UBS Commodities Index. Industrial metals recorded the strongest gains where Aluminum, Copper and Zinc rose 14.5%, 12.7% and 10.2% respectively. The performance for agricultural commodities was mixed while the energy complex ended the month broadly flat, with the exception of gasoline which was up 10.0%.
Gold bullion prices were stronger last month (3.0%), along with the general strengthening of non-US dollar currencies. It ended the month at US$954/oz and continues to trade tightly between the US$900 and US$1000/oz band. As risk aversion and shorter term inflation fear abates, the movement of gold bullion prices is expected to be heavily influenced by the relative movement between US dollar and other major currencies.
The information contained in this report is obtained from various sources deemed to be reliable. It is not guaranteed as accurate or complete and should not be relied upon as such. Opinions expressed are subject to change. This service is but one tool to help make investment decisions. The changing character of markets requires constant analysis and may result in changes. Past performance is not necessarily indicative of future results.
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