Investment Markets Quarterly Newsletter – September 2018 Edition

Australian Economy

Australian politics finally got a little exciting in August with a ‘spill motion’ and subsequent change in leadership. Edging out rival Peter Dutton 45-40 in a ballot, Scott Morrison was sworn in as Australia’s 30th Prime Minister, with Josh Frydenberg stepping into the position of Treasurer.

The RBA also released their quarterly Statement of Monetary Policy in August, stating that they expect GDP growth ‘to be a little above 3% in both 2018 and 2019’, supported by ‘accommodative domestic monetary policy and a positive international outlook’.

The Australian economy continued its expansion, with GDP figures being released showing growth in the June quarter coming in at 0.9%. Most economists had anticipated growth of 0.7%. Stronger domestic demand contributed the most to the outcome. The result means the local economy remains firmly on track to make it 27 straight years without a recession, especially given current low levels of interest rates and increased government spending on infrastructure.On an annual basis, the economy grew 3.4% – its fastest pace in almost six years.

The Australian dollar (AUD) was weaker in the third quarter as trade tensions between the US and China escalated, commodity prices tumbled and the yield differential between US and Australian government debt widened.

Limiting the currency’s decline were a series of encouraging domestic earnings updates, better-than-expected GDP growth data and further merger and acquisition activity.


Global Economy

Trade wars were at the forefront of the news, headlined by the US President announcing a doubling of tariffs on steel and aluminium exports from Turkey. US and Chinese officials also met to find a way out of their deepening trade conflict. However, there was no evidence of progress and both countries effected tariffs covering approximately $16 billion worth of goods imported from one another.

US economic growth for the second quarter was revised upward from an annualised GDP growth rate of 4.1% to 4.2%, while US consumer confidence hit an 18 year high with its confidence index climbing to 133.4 in August from 127.9 in July.

The latest economic news has continued to be reassuring. The key statistic in the U.S. is jobs. There were 205,000 more jobs created in August, and the unemployment rate stayed at a low 3.9%. Remarkably, there are now more job vacancies in the U.S. (6.94 million) than there are officially unemployed people (6.28 million), a situation that first emerged in March and has become more pronounced since then.

The rest of the world is nowhere near as buoyant but is also growing. The latest (September) consensus forecasts from the Economist magazine’s panel of international forecasters show that the eurozone is expected to grow by 1.8% next year, the U.K. by 1.4%, and Japan by 1.2%. These are not tremendous growth rates and they are vulnerable to modest adverse shocks. But all going well, the major developed economies will continue to contribute to the ongoing post-GFC business expansion.

It is also worth noting that all the key BRIC economies will be growing next year. In the case of the two biggest, growth is likely to be very strong, with India expected by the Economist panel to grow by a very substantial 7.3% and China not far behind with a strong 6.3%. Both Brazil and Russia have had their issues, but they too are expected to grow next year (Brazil 2.2%, Russia 1.7%).


Australian Shares

Australian shares are slightly ahead for the year, with the S&P/ASX 200 Index showing a small capital gain of 1.8% and a total return of 5.2%. By sector, the best returns have come from IT stocks (19.2% capital gain) and consumer staples (10.3%). The financials continue to drag on the market following royal commission revelations of poor banking behaviour. More recently the spotlight has turned on insurance companies and the sector is now down 6.1% for the year. Mining has also subtracted from overall performance with a 3.0% drop in value.

Corporate profits have been doing well. The June reporting season was affected by BHP, Commonwealth Bank, and Telstra reporting lower profits – but overall profits were up 8.4% on a year ago. For income-oriented investors a higher than usual proportion (90%) of companies paid a dividend, and in aggregate dividends rose by 13.6% on a year ago.


Global Shares

Global share markets made strong gains in the third quarter, benefiting from another round of positive US earnings results with Apple, Walmart, PepsiCo and all beating analysts’ expectations.

Stocks also benefited from some encouraging European and Japanese earnings, solid German and Japanese growth data, improving US jobs and consumer confidence figures, and news the US had agreed a deal with Mexico to address key parts of the North American Free Trade Agreement (NAFTA).

Limiting the gains was an escalation in the trade dispute between the US and China, weaker commodity prices and ongoing concerns surrounding Britain’s exit from the European Union. Stocks were also impacted by renewed political uncertainty in Italy and fears that fresh economic crises in emerging markets like Turkey and Argentina could spread to other countries.

At the country level, US stocks hit record highs as they recorded their best quarterly performance since the fourth quarter of 2013. Share markets in Japan and Europe were also higher, while the UK and China both struggled.

World shares have made a small gain for the year to date. The MSCI World Index is up 3.4% in terms of its various local component currencies and up 2.3% in U.S. dollars (3.8% including taxed dividends).

The outcome continues to rely on the U.S. performing strongly. In early August, Apple became the first U.S. listed company to be worth a trillion U.S. dollars.


Listed Property

The industrial, office, hotels, and retirement living sectors all have expectations positive returns – particularly retirement living (everywhere), industrial property (everywhere), and offices (mainly Melbourne and Sydney).

The retail sector has been under a cloud for some time with  investors remaining wary of the sector in light of the continued expansion of e-commerce.

Overseas, the ongoing global business expansion is generally helpful for property, although there is a clear distinction between the U.S. and everywhere else. Market conditions in Europe are nowhere near as strong as in America. The large U.K. listed property market is also at significant risk from a poor Brexit negotiation outcome.


Australian Cash & Fixed Interest

The Reserve Bank of Australia (RBA) left the official cash rate on hold at a record low 1.50% with officials showing no urgency to deviate from current monetary policy settings.

At its low point on 3 September, the 10-year Commonwealth bond yield was 2.53%. In recent weeks U.S. bond yields have been on the rise and have taken local rates up with them. The 10-year Commonwealth bond yield is now a bit higher at 2.6%.

The likelihood is that local inflation will gradually pick up more towards the middle of the RBA’s 2.0% to 3.0% target and that U.S. bond yields will continue to rise. Both factors should lead to some rise in local bond yields with the latest bank forecasts suggesting an increase to around 3.2% to 3.3% in a year’s time. Either way, low rates on bank deposits will remain a fixture for some time yet.


Global Fixed Interest

In the U.S. the key 10-year Treasury bond yield has risen in recent weeks with yields now just below 3.0% (2.97%). Although they are still low in absolute terms, yields have moved up a little in other major markets as well, with (for example) the German 10-year government-bond yield up from 0.31% (when emerging markets were more of a concern) to 0.41% currently, while its Japanese equivalent has risen from effectively zero (0.03%) at the start of July to 0.11% now.

The outlook for international fixed interest essentially splits into the U.S. market and everywhere else.

In the U.S. the most likely scenario is that interest rates will head higher. The Fed is charged with steering towards full employment and 2% inflation, and on both scores its job to keep monetary policy very supportive until both targets are reached is now effectively achieved. The Fed no longer needs to keep interest rates very low.

Barring some unexpected shock to the U.S. economy, short-term rates are consequently highly likely to be raised further. The current target range for the fed funds rate is 1.75% to 2.0% with expectations of 2.25% to 2.5% by the end of this year.\


Residential Property

Annually, residential property prices fell in Darwin (-6.1%), Sydney (-3.9%) and Perth (-0.9%), and rose in Hobart (+15.5%), Canberra (+3.0%), Melbourne (+2.3%), Adelaide (+2.1%) and Brisbane (+1.7%).

The housing market slowdown in Melbourne and Sydney is dominating headlines, but the reality is the market is highly divergent. On one hand, Sydney prices have declined by 7.4% year-on-year, while on the other extreme Hobart continues to surge, with prices rising by 16.1%.

Across all measures of demand – including buyer demand, rental demand and property seekers from offshore – Sydney is experiencing the biggest drawbacks.

While Melbourne and Sydney slow down, demand is creeping up in Perth. Although prices are still down year-on-year, the increase in demand is now the third highest in Australia, after Hobart and Canberra. Brisbane is experiencing similar increases, also suggesting that the tough times are over in the river city, which is consistent with recent jobs growth numbers.

Generally, across Australia, the premium market is holding up better than more affordable locations.

The likely outlook over the next six months is continued moderation of pricing in Melbourne and Sydney, while our other markets hold up a lot better. On the positive side, the Australian economy is steadily heading back to growth mode and as the development pipeline has slowed dramatically for apartments, this means less property will be available to buy. This should underpin prices going forwards.


Economic Outlook

We expect volatility to continue into 2019, as investors contend with US policy agenda, potential further US rate hikes, higher bond yields and potential normalisation of monetary policy outside the US. Geopolitical uncertainty poses a further risk, with investors shifting their attention to the threat of trade wars. Acts of retaliation, particularly from China, already have had negative impacts on emerging markets. The spectre of trade war escalation and the potential impacts on global growth will need to be watched closely.

At the time of writing (Oct 12) recent global share market volatility has highlighted these economic concerns – so we remind you to take the long view, knowing that investing is a long road with more than its fair share of bumps.


Sources: Russell Market Insights, Advance Asset Management, Australian Bureau of Statistics, Morningstar Australasia Pty Ltd, Madison Financial Group,

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