February/March 2010
Outlook for Investment Markets
Investors' concern levels have risen as possible sovereign debt defaults and mixed evidence about the scale and speed of recovery in global economic activity have affected confidence. Growth assets have suffered and corporate risk premiums have widened. Looking ahead, however, the consensus view is still for a gradually strengthening world economy and ongoing growth domestically. Allowing for occasional bouts of anxiety, growth assets should still do well in this environment.
Australian Cash & Fixed Interest - Review
Ninety-day bank bill yields were up 0.25 percent for the past quarter to a little under 4.20 percent, reflecting the Reserve Bank's 0.25 percent increase to the cash rate from 2 December, but were flat over the past month. This was again in line with the Bank's subsequent decision to hold further raises for a while. Ten-year Commonwealth bond yields at a little over 5.60 percent are slightly higher than one or three months ago, but there's no underlying trend, as yields are still within the same 5.30 - 5.80 percent trading range that has prevailed since the middle of last year. Corporate bond yields have inched down a little, the average yield down 0.40 percent over the past quarter to 6.75 percent. The $A was unchanged in overall trade-weighted value for the past quarter, but has dropped from 92 to 90 cents against the firming $US.
Australian Cash & Fixed Interest - Outlook
The main change likely in coming months will be higher short-term interest rates. The Reserve Bank's last formal statement said that it was "likely that monetary policy will, over time, need to be adjusted further". Financial markets expect the Bank to get on with it fairly smartly - the futures market is picking 90-day bank bills to be one percent higher by the end of the year. This may be an overestimate, as Governor Stevens told Parliament's Economics Committee on 19 February that increases of 0.50 to one percent were on the cards, but either way shorter-term interest rates are on the way up.
For Commonwealth bonds, there is no particular pressure such as the threat of inflation, or from heavy supply of new debt for rates to move far from current levels. The direction of the $A always remains hard to call, but one new factor is the stronger $US, which bottomed out at the end of last November and has been rising steadily since.
This may make further overall appreciation of the $A more difficult, and the recent pattern of $A steadiness in overall value but slippage against the $US may continue in coming months.
Australian & International Property - Review
Performance numbers for the Australian real estate trust sector look sub-par - the S&P/ASX200 AREIT Index was down 0.80 percent for the past month, and 2.70 percent for the quarter - but the sector has effectively been trading sideways since last October, with week-to-week volatility but no real underlying trend. The main corporate news recently has been the latest earnings report from the sector's 700-pound gorilla, Westfield: operating income from shopping centres was up only modestly (1.60 percent), good results from Australia/New Zealand (+5.90 percent) offset by weaker results in the US (-3.90 percent) and the UK (-4.20 percent). Global property stocks have shown the same pattern as global shares more generally. The EPRA/NAREIT ex-Australia index of global property shares hedged back into $A topped out in the first half of January, weakened into February, and has rallied a bit in the last couple of weeks. The index was unchanged for the past month, and showing a small 1.20 percent gain over the past quarter.
Australian & International Property - Outlook
Operating earnings from the Australian listed property sector are picking up, devaluation hits to capital values are lessening, and balance sheets continue to be repaired, all of which is however a gradual process.
GPT for example noted at its recent results presentation that while it's now in much better shape than in the depths of the sector's crisis, it still has to complete further asset sales before it ends up where it wants to be. There may also be increased M&A activity as the stronger survivors pick off their weaker brethren. However, the sector's not especially cheap in terms of discount to net assets and the pick-up in yield relative to Commonwealth bonds is only modest (0.50 percent or so, adrift of what's available from corporate bonds), so investors may continue to wait until restructuring risks are out of the way.
There's been little fundamental change to the outlook for the global property sector, where the main points are the benefits of a gradually improving global economy and ongoing balance sheet restructuring. This is overlaid by very different prospects from one market to the next - regional indices show a very volatile mix of market by market performance - and the overhang from sectors still in trouble (notably US commercial property, which US regulators have mentioned recently as an ongoing issue). One encouraging development is evidence of greater investor confidence. The UK Investment Management Association has found that retail investors, substantial net sellers of property funds in 2008, turned increasingly positive on the sector throughout 2009. This may say more about retail investors chasing yield when returns from government bonds and bank deposits are so low than about the prospects for the sector. Overall, this is an area where active, market by market and fund by fund management will remain very important for investment performance.
Australian Equities - Review
Australian shares have followed world sharemarkets closely, peaking in the first half of January, selling off into February, and picking up again more recently, though not by enough to regain January's peaks. The S&P/ASX200 Accumulation Index was down 0.70 percent for the past month and flat for the past quarter. There was nothing to choose between Industrials and Resources for the past month - both were down 0.70 percent.
Australian Equities - Outlook
Australia came through the global recession in good shape by OECD economy standards, with positive GDP growth in 2009 and a much smaller-than-expected rise in unemployment. The outlook continues to look good. As Reserve Bank Assistant Governor Phillip Lowe pointed out in a recent speech, Australia has been lucky to find itself in the faster bloc of a "two-speed world", well-placed to sell into strong Asian growth. While the occasional indicator is weak (the latest NAB business opinion survey contained evidence of slower sales and lower profits in January), most point to a good year ahead, particularly the Westpac/Melbourne Institute leading indicator. Consensus forecasts have the Australian economy growing by three to 3.25 percent a year over the next two years. If there are no policy mistakes such as a premature monetary or fiscal tightening and absent any double-dip global downturn or other unpleasant surprise, the outlook for the Australian sharemarket continues to look supportive.
International Fixed Interest - Review
Short-term interest rates have remained low around the world as monetary policy remains supportive of economic recovery and financial work-out. The higher level of investor anxiety about sovereign debt default, however, has led to modestly higher yields (and hence lower capital values) on government bonds, the JP Morgan Global Government Bond Index recording small falls for the past month (down -0.40 percent) and quarter (-0.80 percent). The heightened perception of risk has also fed through into higher corporate bond yields.
International Fixed Interest - Outlook
There's little prospect of currently ultra-low interest rates rising appreciably any time soon, as recovery in the developed world is still fragile. The futures market expects the US Fed funds rate to have risen to only 0.50 percent by the end of this year. Pressures leading to higher government bond yields are growing because of the massive supply of new bonds, the gradually firming global economy, the increased prospect of inflation, and increased concerns about the more indebted sovereign issuers. And it looks as if the huge rally in corporate bonds has finally run its course. Corporate bond prices, especially for more risky borrowers, had surged through 2009 and into early this year, as credit risk premiums had contracted sharply once the global credit crisis looked on the mend.
This now looks to have peaked in January, and prices of riskier corporate debt have fallen over the past month in both the US and Europe. Investors may still be interested in earning the risk premium income from corporate credit, but large capital gains now look unlikely from here.
International Equities - Review
World shares started the year well, the MSCI World Index peaking on 11 January, at which point the index had risen 62.0 percent from its low point in the depths of global financial crisis in March 2009. Recent weeks have been harder going, shares losing ground in the rest of January and into early February. Prices have picked up in the second half of February, but world shares are still some 3.60 percent below their January peak. The net effect has been to leave global shares up marginally (+0.30 percent) for the past month, and up modestly (+2.0 percent) for the quarter in foreign currency terms. The strength of the $A, however, has eroded both gains, and in local currency terms world shares were down 1.10 percent for the month and 1.30 percent for the past three months.
International Equities - Outlook
There are several key reasons for the wobbles that have hit world sharemarkets since January. The first is the fear of problems emanating from the 'PIGS' economies of Portugal, Ireland/Italy, Greece, and Spain. Concerns centre in particular on the impact of any sovereign debt default, especially if concentrations of holdings of (say) Greek debt at some financial institutions were to lead to another flare-up of the global credit crisis. A second reason for sharemarket weakness has been fluctuating opinions about the strength of global economic recovery. Markets have been very sensitive to any hints that the recovery might not be on track. A very recent example was the near-global sell-off on news that the Conference Board's indicator of US consumer confidence had dropped unexpectedly.
A third reason has been concerns about the eventual tightening of fiscal and monetary policies that is inevitable in the developed world. Deficits in the order of 10.0 percent of GDP (as in the US at present) will need to be wound back, and ultra-easy monetary policy will need to move back to more normal conditions to avoid either inflation or another round of cheap money-fuelled asset price bubbles. There has been intense interest, for example, in the US Federal Reserve's decision on 18 February to raise its emergency discount rate (to a still very low 0.75 percent), even though the Fed argued that the move did not "signal any change in the outlook for the economy or monetary policy". Finally, some sort of slowdown might have been expected for global shares after the strong rises through 2009.
There's still good reason to expect a global recovery to become more obvious as 2010 unfolds. Asia is recovering very quickly (as latest GNP data out of Taiwan has shown); China is still powering ahead (with a consensus forecast of 9.70 percent growth this year), as are some other large emerging economies; and a modest recovery looks likely for the US economy, where the Wall Street Journal's forecasting panel is picking three percent growth in 2010. While there are still weak spots - notably the Eurozone, especially its peripheral members; the UK; and Japan - and risks - sovereign default, ham-fisted stimulus withdrawal, and left-field 'accidents' - the outlook for global business activity looks better than in 2009. Whether sharemarkets will have confidence to place their bets on that outlook remains to be seen. They may need more birds in the hand before then.
Performance periods refer to the month and three months to 24 February 2010.
