Morningstar Economic Update - September 2012
Written and accurate as at: Sep 10, 2012 Current Stats & Facts
Growth assets had a resurgence over the past month, due mainly to increased optimism that the European Central Bank would weigh in more effectively to address the Eurozone's debt problems. Bond yields correspondingly rose as investors felt less need to hold 'safe haven' assets.
While there are some grounds for optimism about further gains for growth assets, the outlook remains heavily and unpredictably dependent on political outcomes in the Eurozone (to address debt, fiscal, and growth problems), in the United States (to resolve fiscal gridlock), and in China (to continue to deliver high rates of growth without sparking consumer price and property inflation).
Australian Cash & Fixed Interest – Review
Short-term interest rates fell over the past month, 90-day bank bills down from 3.75 to 3.55 percent. This reflected the fact that the Reserve Bank of Australia cut the cash rate again on 5 June from 3.75 to 3.50 percent. Longer-term rates followed the global pattern: high levels of investor anxiety at first pushed 'safe haven' government bond yields down by late July, 10-year Commonwealth bond yields reaching a low point of 2.70 percent, but more recently improved confidence has seen yields move up, the 10-year yield now close to 3.40 percent.
Other long-term rates such as the three-, five-, and 10-year swap rates have followed suit. The $A was a beneficiary of improved investor sentiment. It had been as low as 97 US cents in early June when investors had been most rattled, but recovered in more recent months and was trading around the US$1.05 mark in late August. The $A gained 0.50 percent in trade-weighted terms over the past month, and was up a substantial 7.40 percent on its weak levels of early June.
Australian Cash & Fixed Interest – Outlook
In its August Monetary Policy Statement, the Reserve Bank stated that "with a more subdued international outlook, inflation expected to be consistent with the target and growth of the Australian economy close to trend, the stance of monetary policy – which had resulted in borrowing rates a little below average – remained appropriate". No change for now, in short, and the Bank also gave no hint about what way it might move if it were to bestir itself. The markets have their own view, and expect between one and two 0.25 percent interest rate cuts over the next year.
What happens to local bond yields is inextricably bound up with the largely unforecastable state of global investor sentiment. Further improvements in optimism could see yields continue to rise, while further outbreaks of nerves would see them relapse to earlier low levels. At the moment, forecasters' best guess appears to be that globally, affairs will continue to improve and yields will continue to rise. The latest forecasts from National Australia Bank and Westpac, for example, have the 10-year yield rising to 3.70 - 4.0 percent in a year's time, in both cases predicated on a gradual rise in the US 10-year yield to 2.50 percent. The same is true of the outlook for the $A. While there is no strong consensus, forecasters for the most part reckon that a climate of improved investor sentiment will enable the $A to stay above parity with the $US: three of the big four banks have the $A in the US$1.01 -1.04 area in a year's time (ANZ is a bit less optimistic at 98 cents).
Australian & International Property – Review
The Australian listed property sector had another decent month with a modest capital gain of 0.90 percent from the S&P/ASX200 A-REIT Index and a total return including dividends of 2.10 percent. The sector continued to deliver relatively low volatility, slow and steady gains. Global listed property shared a low point in early June with wider global sharemarkets, but the paths have since diverged.
Global property shares rose in June (as did global shares), but property did not follow the global selloff in July, nor did it have the same rally in August as equities more generally. The EPRA/NAREIT Global Index (ex-Australia, hedged into $A) ended up delivering a 1.80 percent return over the past month. There were similar outcomes in Japan (+3.70 percent), Europe ex-United Kingdom (+3.50 percent), the UK (+3.10 percent), and Asia (+2.70 percent), while the US (+0.30 percent) was a bit behind.
Australian & International Property – Outlook
Australian listed property trusts have been a good proposition for investors this year. The S&P/ASX200 A-REIT Index closed 2011 at 777.52, and is currently at 915.31, having delivered a capital gain of 17.70 percent (with the income yield on top), compared to 8.10 percent for the sharemarket as a whole, and with lower volatility. It's an open question, though, whether the AREITs can continue to deliver these levels of absolute and relative performance.
There's nothing much wrong with the overall economic outlook, although as in many other developed economies, cautious households are being careful with their spending. As one of Westfield's co- Chief Executives said at its latest (and good) profit report, "There clearly needs to be a spark to kick [consumer spending] along". But the sector will find it harder going on two other fronts. If wider sharemarkets have indeed turned more optimistic, the safety value of property will be reduced. And the other factor which has been attracting investors, the relative income pick-up between REITs and fixed interest, is also under pressure.
The gap between the 5.50 percent yield from listed property and the yield from bonds has already started to close, and is likely to narrow further. The same arguments apply, except more so, to global property. Yields on global REITs have been falling, the global yield now 3.70 percent, while in the major component of the global index, the US market, the yield is down to 3.40 percent, and all this is happening at a time when global bond yields have started to rise, however tentatively, from exceptionally low levels. Global property markets also have less of the 'safety of bricks and mortar' aspect to them than the Australian listed property sector.
As the latest quarterly survey of global commercial property from the UK's Royal Institution of Chartered Surveyors showed, conditions vary exceptionally widely from market to market. Some are in very good shape: rental increase and capital gains expectations are highest in Brazil, China, Russia, and Thailand, and Germany and the US also show up in reasonably good condition. But conditions are utterly dire at the other end of the spectrum, dominated by the Eurozone 'PIIGS' (Portugal, Ireland, Italy, Greece, Spain): rentals and capital values are falling, and bottom-fishing investment demand has not yet emerged. There's also a substantial overhang of distressed property expected to come onto the market, with few takers ready to absorb it. While there are genuine opportunities at the better end of the sector, this adds up to a decidedly mixed outlook for global listed property overall.
Australian Equities – Review
After joining global sharemarkets in sinking to a low point in early June, the Australian sharemarket has been moving more or less steadily upwards. The S&P/ASX200 Index gained 4.40 percent for the past month, and is now up 10.0 percent from its low point on 4 June. The miners contributed to the gain: the S&P/ASX300 Metals and Mining Index had been falling more or less consistently since April last year, but bottomed out on 25 July and has risen modestly since. The longer-term context, though, is that at its latest level (4383), the S&P/ASX200 Index is still well in the middle of the 4000 - 5000 trading range that has prevailed over the past three years.
Australian Equities – Outlook
Latest data on the Australian economy has been mixed. Retail sales have been quite strong, but this is widely-believed to reflect the impact of a variety of one-off fiscal handouts. Employment has been up and down: 28,300 jobs disappeared in June, but 14,000 were clawed back in July, while the Australian Bureau of Statistics' 'trend' measure of new jobs (which aims to iron out month-to-month volatility) registered only very modest growth in July (4,000). More positively, the unemployment rate has stayed low by international standards at around the 5.20 percent mark. Neither consumers nor businesses currently seem very happy.
The Westpac/Melbourne Institute survey of consumer confidence for August produced a result that Westpac called "cautiously pessimistic" and "unusual", given that the fiscal handouts, lower interest rates, and a steady unemployment rate might have been expected to have households in a cheerier mood. And the July National Australia Bank business survey showed that business conditions were a bit weaker than usual, analysts consequently estimating that economic growth is similarly a bit slower than usual. They estimate that their survey is consistent with 2.50 percent growth, which is lower than the long-term trend rate of three percent.
Irrespective of exactly what is going on at the moment, the Westpac/Melbourne Institute Leading Index has perked up in recent months, suggesting a pick-up from the current slow patch, and forecasters agree that 2013 looks to be another reasonably solid year. The Reserve Bank, for example, expects three percent growth next year and again in 2014, and the major banks have similar views, their latest forecasts for 2013 ranging from 2.90 to 3.60 percent growth. The booming mining sector will slow down at some point – the Reserve Bank expects resource project investment will peak in 2013/14 – but as the Bank also noted in its latest monetary policy minutes, at that point the completed projects will start generating increased export revenue, and the currently weaker sectors of the 'two-speed economy' are likely to pick up to more normal states of activity. While Australia is relatively vulnerable to upsets in world trade, and things could easily go unexpectedly pear-shaped in the US, the Eurozone, or China, the current consensus outlook of further non-inflationary growth remains supportive for Australian shares.
International Fixed Interest – Review
Investors have for the most part remained deeply concerned in recent months about the global economic outlook and in particular the prognosis for the Eurozone's debt and fiscal issues. 'Safe haven' demand for government bonds has remained strong as a result: the 10-year US Treasury yield reached a new low of 1.40 percent on 25 July. Investors have since become somewhat less fearful, and the US 10-year yield has backed up to just over 1.80 percent, but even at these slightly higher levels, yields in the jurisdictions regarded as the 'safest' have remained exceptionally low by historical standards. The 10-year yield on Swiss government debt is 0.60 percent, in Japan 0.80 percent, and in Germany 1.50 percent.
The modest improvement in investor optimism has seen the yields on the more troubled Eurozone governments' bonds decline. Spain's 10-year bonds were yielding over seven percent at one point, a level regarded as unsustainable over the longer haul, but are now down a bit to 6.50 percent, while Ireland's 10-year yield is lower still at 6.10 percent. Markets remain more sceptical about Portugal (9.70 percent), while Greece is priced on the firm expectation of further losses to bondholders (24.0 percent). Modestly lower anxiety levels saw European credit spreads fall recently. The latest modest increases in developed economy government bond yields (which produce capital losses) and their very low running yields mean that the returns from holding government bonds have been very low – global government bonds have returned only 0.50 percent over the year to date. Corporate bonds have returned a rather better 5.60 percent, while the best returns have come from high-yield (lower-quality) corporate debt (10.70 percent) and emerging economies' government bonds (10.90 percent).
International Fixed Interest – Outlook
The extraordinarily low yields on the more creditworthy government bonds have persisted for far longer than almost anyone would have forecast. The reasons are clear, albeit only in hindsight: the scale of the Eurozone's debt problems and the lacklustre pace of US economic growth. For all we know, Eurozone rescue efforts could fall over in a heap, triggering another round of panic buying of bonds, and there could well be further quantitative easing (central bank bond-buying). There is a chance that bond yields could revisit the low points of earlier this year.
A more likely outcome, however, is some gradual rise in yields as the Eurozone gets to grips more effectively with its issues, US growth picks up, and investors' concerns continue to wind down from their previous state of high alarm. Many forecasters are consequently predicting a progressive rise in bond yields, back to levels that would give investors some small real rate of return over and above inflation. The economists polled by the Wall Street Journal are picking the US 10-year yield to rise to 2.50 percent by the end of 2013 and to 3.25 percent by the end of 2014. Forecasts of rising yields have been wildly wrong over the past couple of years, but if they are correct this time, investors will need to be wary of the potential for capital losses.
International Equities – Review
World shares turned for the better over the past month. They had been in very poor shape: the MSCI World Index had dropped 12.0 percent between its high point in March and its low point in early June, and although world shares improved during the rest of June, they weakened again in July. It has been mostly onwards and upwards since 25 July, though, with one setback in early August when markets at first did not like the look of the European Central Bank's latest initiative to deal to the debt issues of the more troubled Eurozone members.
The upshot is that world shares were up 4.40 percent for the past month and up 11.40 percent from the depths of pessimism recorded in early June. The Dow Jones Index in the US was up three percent, and the S&P500 3.70 percent, while the UK's FTSE100 gained 3.60 percent. Japan, which had an especially gruelling time in the June quarter, was up 4.30 percent. The major beneficiaries, however, were the Eurozone markets, Germany's DAX up 6.90 percent and France's CAC40 up 10.0 percent. The emerging markets mostly followed their developed counterparts, weakening to early June, recovering and relapsing in June and July, and strengthening since.
The MSCI Emerging Markets Index was up 3.30 percent for the past month, and 7.80 percent on the early June low. There were few differences on a regional basis, with similarly-sized gains in Asia (+3.50 percent), Eastern Europe (+2.10 percent), and Latin America (+3.10 percent). China was the major exception, where prices went largely sideways in August, and are down 2.30 percent on a month ago.
International Equities – Outlook
The improvement in investor sentiment over the past month has hinged on a stronger expectation that
European governments will get on top of the Eurozone's assorted problems. These include the high debt levels of the 'PIIGS' countries, ongoing fiscal deficits in many economies, recession, and the longer-term need for structural reforms to deal with entrenched levels of high youth unemployment. In a way, the improvement in confidence is rather surprising. Although the European Central Bank indicated that it would be prepared to buy the short term debt of countries that embraced bailout reforms, little else of substance appears to have occurred to justify a more upbeat view. It's clear, for example, that Greece is failing to meet any of the main targets set in its last bailout.
The economic news has also been poor: Eurozone growth declined by 0.20 percent in the June quarter, and is down 0.40 percent on a year ago. Germany, the powerhouse of the zone, grew by only 0.30 percent in the quarter, and France, the other main axis of the zone, has not grown at all in any of the latest three quarters. In sum, the recent rise in European equities and the associated gains for global sharemarkets represent something of an act of faith thus far that the European authorities will get on top of their problems. It's possible, too, that European shares had overshot to the downside in the earlier period of greater pessimism – valuation metrics for the European markets were showing that shares were relatively cheap – and even without banking on any new policy initiatives, some of the rise could reflect investors taking a less panicky view than they did before.
While it's promising that investors appear to feel that the European authorities will get their act together, the outlook remains completely dependent on political developments that could go either way. Outside the Eurozone, the news has mostly been brighter. The major issue has been the pace of US economic recovery, and in particular the rate of jobs growth. Forecasters had not been expecting good jobs numbers for July, with a consensus expectation of 100,000 new jobs and forecasts ranging from only 70,000 to at most 165,000. The actual number came out right at the top end of expectations at 163,000. The numbers remain relatively modest by the standards of historical recoveries, though, and forecasts for the US economy correspondingly remain cautious, relatively low 1.90 percent growth expected for this year picking up a bit to 2.40 percent next year and three percent in 2014 (going by the latest Wall Street Journal poll of forecasters).
As in the Eurozone, however, politics could intervene, particularly if US legislators fall off the end-year 'fiscal cliff' (mandatory tax increases and spending cuts which would kick in if some other agreement is not reached). The economists polled by the Wall Street Journal felt by a 9:1 margin that without a deal, ongoing political uncertainties would hamper the US economy's performance this year. They weren't asked about the fiscal cliff's impact on 2013, if it was allowed to occur, but it would clearly be substantial and negative. Issues other than the Eurozone and the state of the US economy have not had much of a chance to get a look in over the past month, but the other major issue the markets have had to mull over is the outlook for China, which has been the key to growth in the wider Asian region as well as a major driver of global commodity prices.
The latest economic data has been mixed, but is not showing the sharp overall slowdown pessimists had feared. The consensus view is that Chinese growth will bottom out at 7.50 – 8.0 percent this year, and pick up a bit to 8.0 – 8.50 percent next year, given that the authorities still have extensive policy ammunition in reserve. To an unusual degree, then, the near-term outlook for global sharemarkets will largely be determined in the political sphere, with politicians needing to produce sensible plans in the Eurozone, the US, and China. The recent rise in share prices suggests that investors believe the politics will play out reasonably well: that may be so, and the potential payoff could be great, but the potential risks are at least equally as great.
Performance periods refer to the month and three months to 22 August 2012.
Economic Update
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