Morningstar Economic Update - October/November 2012
Written and accurate as at: Oct 16, 2012 Current Stats & Facts
Outlook for Investment Markets
The outlook for growth assets remains broadly positive, and investor confidence has been boosted by further quantitative easing by the US Federal Reserve and moves by the European Central Bank. Interest rates are likely to remain very low everywhere for quite some time yet. The Australian economy should still put in a reasonable performance by developed economy standards, but the sharemarket has been priced on the good times continuing to roll at the same strong pace as before, which is now looking increasingly questionable.
Australian Cash & Fixed Interest – Review
Australian short-term interest rates were steady over the September quarter, 90-day bank bill yields at 3.50 percent. The Reserve Bank of Australia cut the cash rate by 0.25 percent to 3.25 percent from 3 October, and other short-term rates followed suit, the 90-day yield 3.20 percent at the time of writing. 10-year commonwealth bond yields have continued to track overseas government bond markets closely. Corporate bond yields have been lower. The $A rose from around US$1.019 to $1.046 over the past quarter, mostly because of the global weakness in the $US. The $A also gained a modest 0.50 percent in overall trade-weighted value.
Australian Cash & Fixed Interest – Outlook
The futures markets are currently expecting 90-day bank bills to be trading at 2.60 percent by the middle of next year. This would suggest two more 0.25 percent cuts by the Reserve Bank to the cash rate. Australian bond yields are likely to continue to take their cue from global bond markets. With yields overseas now expected to remain low for an even more protracted period, local yields are also likely to stay around current levels. While not especially attractive, they can function as helpful portfolio insurance against further economic uncertainties.
The $A remains uncomfortably high from the perspective of the export, tourism, and a number of other sectors. The $A has remained higher than might have been expected given the decline in export prices and the softer global outlook. However, there does not seem to be any catalyst on the horizon that would weaken the $A. If anything, improved international investor sentiment could see further buying of the $A, which tends to rise when investors are less worried about the global economic outlook.
Australian & International Property – Review
Australian listed property has been healthy, the S&P/ASX200 AREIT Index posting a 5.60 percent capital gain for the past quarter and a total return including pre-tax dividend income of 6.90 percent.
Global listed property shared in the strong market for equities more generally, the EPRA/NAREIT Index ex-Australia hedged into $A registering a 5.10 percent gain. Asia was the star performer among the regions, with a 12.60 percent gain (in $US); Japan (+6.0 percent in yen), the United Kingdom (+5.50 percent in sterling), and Europe ex-UK (+5.10 percent in euro terms) were in the middle; and the US brought up the rear with a marginal 0.10 percent rise.
Australian & International Property – Outlook
The outlook for Australian listed property remains broadly positive. Although the sector remains highly-concentrated by number of stocks and sub-sectors, the healthier balance sheets, reduced gearing, more sustainable payout ratios, divestment of offshore assets, return to traditional rent collection, and prospect of continuing high and comparatively stable income are all attractive characteristics. The trusts also appear to be reasonably insulated from the current economic slowdown, which so far has been having a relatively minor impact on rentals and occupancy levels. The Australian listed property sector continues to look capable of delivering attractive income with comparatively low risk to capital.
Global listed property is more problematic. Valuations in the US have been pushed up to extreme levels by investors' search for yield in a low interest rate world. Valuations in Europe are more reasonable, but Asian real estate trusts have been running hot. Eurozone listed property markets may still be absorbing the distressed property portfolios of the Eurozone banks, with further losses still to come. So overall, the outlook for global listed property is decidedly mixed, with distinct signs of overheating in the key US market.
Australian Equities – Review
Australian shares had a good quarter, the S&P/ASX200 Accumulation Index gaining 7.10 percent. The industrials were relatively quiet (+1.70 percent), and the resources sector a bit better (the S&P/ASX300 Metals and Mining Index gained 4.60 percent). The best-performing sectors were consumer staples (+9.60 percent) and financials (+9.20 percent).
Australian Equities – Outlook
The Australian economy is in an unusual situation by current international standards. Inflation and the fiscal deficit are well under control, and the growth outlook still favourable by comparison with the majority of developed world countries, which is supportive for corporate profits and share valuations. Increased global investor confidence could renew interest in Australia, particularly from income-oriented investors looking for attractive dividend yields in a world where interest rates had moved even lower. The major issue is the combination of a high $A with falling commodity prices. The iron ore price could fall further, severely affecting the profitability of a number of leading resources stocks. The hot sector of the 'two-speed economy' looks like beginning to wind down, while the colder sector is not guaranteed to take up the slack. Investors may have already been capitalising unsustainably high profit margins into share prices. Business surveys also suggest stronger headwinds for the Australian economy, with weaker trading conditions, reduced new orders, and lower profitability in the retail sector. The Australian economy is still picked to grow by around three percent in 2013, a good outlook by developed world standards, but the sharemarket has been priced on the good times continuing to roll at the same strong pace as before, and that is now looking increasingly questionable.
International Fixed Interest – Review
Bonds have been bought, and their yields fell, during periods of investor concern. When investors were more confident, they sold bonds, whose yields rose. The US 10-year Treasury yield rose and fell in August as a bout of optimism was followed by pessimism, and then rose strongly in September as investors reacted warmly to the US Federal Reserve and European Central Bank’s monetary policy stimuli. Some of the gloss then wore off as investors started to think more about the effects of further austerity packages in the Eurozone, and the yield dropped back to 1.63 percent. The end result for the quarter was that despite all the to-ing and fro-ing, the US Treasury yield ended up pretty much where it started at 1.63 percent. There were marginal falls in the government debt of Japan, Switzerland, and the United Kingdom, and larger falls in the Eurozone countries. In the troublesome countries, Greece dropped from close to 26.0 to just under 20.0 percent, Portugal from 10.25 to just over nine percent, and the yield on Spanish government debt from 6.40 to just under six percent.
The Barclays Capital Global Aggregate Index had at the end of September produced a total return of 5.20 percent, made up of a modest return from government bonds and a substantially higher return from global corporate debt. The highest returns were achieved by the riskier lower credit quality corporate bonds, which returned 12.30 percent in the US, 14.40 percent in the emerging markets, and a substantial 20.90 percent return in Europe.
International Fixed Interest – Outlook
Interest rates in most of the developed world remain extremely low, and long-term bond yields are being held down by aggressive bond-buying by the major central banks. The recent strength of the gold price, a traditional shelter from inflationary fears, suggests that some investors are already worried about inflation. But this may be some distance away. The yields on global bonds remain unattractive, but with little imminent risk that yields are likely to rise any time soon, global bonds
can act as useful portfolio insurance against economic uncertainty. At some point, inflation will rise, and bonds will then be very vulnerable, but this still looks well down the track.
International Equities – Review
International shares have zigzagged as investor confidence has ebbed and flowed. The MSCI World Index dropped in July, recovered in August only to lapse again later in the month, and put on a strong rally in September but dropped back again afterwards. The Index produced a five percent overall gain in overseas currency terms over the past quarter. This largely carried over into a good $A outcome, as the local currency was only slightly higher in overall value.
Almost all the major developed markets shared in the advance. Top billing went to Germany (up 12.50 percent). The other major European markets were more modest, France's CAC40 up 4.90 percent and the UK FTSE Index up 3.10 percent. The S&P500 Index in the US gained 5.80 percent. Japan’s Nikkei Index was down 1.50 percent on evidence of slower economic activity than anticipated. The emerging markets also did well. The MSCI Emerging Markets Index was up 5.10 percent, much the same as the developed economies, with Eastern Europe (+8.50 percent) the strongest region, Asia doing alright (+5.50 percent), and Latin America trailing a bit (+3.20 percent), despite Brazil's 8.90 percent gain. The exception was China, where the Shanghai Composite Index dropped a sharp 6.30 percent, the current slowdown in growth giving investors food for thought.
International Equities – Outlook
While the global economic outlook still remains fairly reasonable, there are increased risks. On the positive side, the global economy is still growing at a modest rate. The JP Morgan/Markit Global Manufacturing and Services Purchasing Managers Index, which tracks global business activity, has the world growing at about 1.50 to two percent. The pickup in activity was "heavily reliant on the US", which has been doing rather better than expected, notably with a surprise fall in the latest unemployment rate from 8.20 to 7.80 percent. Other leading developed economies are in poorer shape, and the Eurozone remains a tough challenge. Several countries are only in the early stages of devising and implementing reforms to get their deficits under control and their economies working more effectively. Lack of commitment to effective reforms and political protests against fiscal austerity could prevent necessary reforms being carried out, and austerity programs will kick in when economies are already weak. The US also has difficult fiscal policy decisions to make, and share valuations would be too optimistic if taxes are in fact raised. The International Monetary Fund’s latest outlook is for relatively subdued (3.60 percent) world growth in 2013, the developed economies growing by only 1.50 percent but the developing economies chipping in with a solid 5.60 percent. There is a higher-stakes risk that policy missteps derail the expected growth of the world economy. This all adds up to a more subdued outlook for international shares, and at current higher share price levels, the risk-adjusted payoff is looking less promising.
Performance periods refer to the month and three months to 9 October 2012.
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