Market commentary: monthly update
Global share markets rise
Global share markets made strong gains in April, driven in part by increasing optimism the US and China will soon end their trade impasse and better-than-expected Chinese growth; the world’s second-biggest economy expanding 6.4% in the first quarter. Stocks also benefited from expectations central banks will remain patient in their approach to monetary policy, some encouraging US jobs and manufacturing activity data and better-than-expected earnings results from the likes of Microsoft, PepsiCo and Facebook.
In saying that, there were some notable misses on the US earnings front, including Goldman Sachs, Exxon Mobil and IBM. Limiting the advance was some disappointing European economic data and ongoing geopolitical uncertainty, including Brexit, renewed talk of a potential US-Europe trade war and further civil unrest in Venezuela.
Also impacting stocks was the International Monetary Fund (IMF)’s decision to downgrade its global growth outlook. The IMF, citing softer outlooks in most major economies and evidence that higher tariffs are hurting trade, cut its 2019 global growth target from 3.5% to 3.3%; the lowest since the global financial crisis.
At the country level, Japanese, European and US stocks posted some of the strongest gains for the month. In the US, both the benchmark S&P 500 Index and the tech-heavy NASDAQ hit record levels in April, while European stocks hit an eight-month high. Share markets were also stronger in the UK and China.
Australian shares performed well in April; the local market benefiting from strong performances across the ‘Big Four’ banks and speculation the Reserve Bank of Australia (RBA) may soon cut interest rates following yet another disappointing inflation reading. Sentiment was also buoyed by encouraging US-China trade negotiations and some notable domestic corporate activity, including Nippon Paint’s play for Australian paint manufacturer, DuluxGroup.
Limiting the gains was weakness across the major miners and a modest uptick in the local jobless rate, which rose from a near eight-year low of 4.9% to 5.0% in March. Stocks were also impacted by ongoing geopolitical uncertainty and the IMF’s move to cut its global growth forecast.
Interest rates unchanged
The RBA left the official cash rate on hold at a record low 1.50% in April. In its post-meeting statement, the Bank noted the domestic labour market remains strong, with a significant increase in employment and some pick-up in wages growth. According to officials, continued improvement in the labour market is expected to see a further lift in wages growth over time, though this is likely to be a gradual process.
The RBA also conceded recent gross domestic product (GDP) data paint a softer picture of the economy than do the labour market data. GDP rose just 0.2% in the final quarter of 2018 to be 2.3% higher for the year. Growth in household consumption is being affected by the protracted period of weakness in real household disposable income and the adjustment in housing markets. The drought in parts of the country has also affected farm output. Offsetting these factors are higher levels of spending on public infrastructure, an upswing in private investment and steady employment growth.
Meanwhile, the Bank said underlying inflation is expected to pick up gradually over the next couple of years. The RBA’s central scenario is for underlying inflation to be 2.0% this year and 2.25% in 2020.
We maintain the view that market pricing of RBA rate cuts is too aggressive. Whilst the March quarter inflation print was soft, we think the Bank has become more focused on labour market data. Given the labour market remains solid, and forward indicators remain positive, we believe the RBA is likely to remain on hold. The risk to this view is a deterioration in labour market data.
Australian dollar flat
The Australian dollar (AUD) was flat in April. The local unit benefited from stronger iron ore and oil prices, as well as some encouraging domestic economic data; including better-than-expected consumer confidence and retail sales figures. Offsetting these factors was speculation the RBA may soon cut interest rates and a further widening in the interest rate differential between US and Australian government debt.
The AUD rose 0.4% against the British pound and was flat against the Japanese yen. It fell 0.7% against the USD and 0.2% against the euro, while the broader Australian Trade-Weighted Index1 ended the month unchanged.
Global markets began 2019 positively as central banks turned dovish, trade war tensions eased and Chinese authorities announced stronger-than-expected stimulus measures. However, late-cycle risks remain elevated and markets are conflicted between incoming data that’s pointing toward slower global growth and forward-looking factors that suggest improvement later in the year. We believe economic conditions will modestly improve throughout 2019, though we see the potential upside for equities as limited.
In a volatile equity market environment, we have a broadly neutral view on global equities overall. We continue to favour an underweight to the US due to expensive valuations, while valuations in Europe and Japan are considered more reasonable. For Europe, we believe consensus expectations have become too pessimistic. Our base case is for negative risks to fade in 2019 and for corporate earnings and economic growth in the region to improve. We also like the value offered by emerging markets, particularly given their attractiveness relative to developed markets. Emerging markets should benefit from Chinese stimulus, the tailwinds from a pause in US rate hikes and a potential US-China trade deal.
For fixed income assets, we see the cycle as a headwind for bond markets given the risk of rising inflation pressures. We expect a US rate hike later in 2019, with evidence of wage growth starting to threaten corporate profit margins. Many bond markets are very expensive given yields are well below fair value, especially in Germany and Japan. In credit markets, we believe high-yield bonds remain expensive, which is typical late in the cycle when profit growth slows and concerns over defaults rise.
In terms of currencies, we maintain a preference for the Japanese yen. We believe the yen is undervalued, has attractive ‘safe haven’ properties due to its strong, negative correlations with global equity returns, and is under-owned from a market positioning standpoint.
We also think the pessimism around the US economy is overdone and that the USD still has upside potential before its bull run ends for this cycle. The strength of US growth relative to the rest of the world will continue to have implications on USD movements.
In Australia, although the RBA has flagged risks to the domestic growth outlook, the labour market remains solid. Our view is that the market has become too pessimistic on pricing in rate cuts for 2019. We think the AUD will continue to be impacted by the US-Australian bond yield differential, geopolitical risks involving China and other emerging markets, and commodity price movements.
Although we expect late-cycle risks to rise further, we nonetheless expect the current US expansion to continue through 2019. In saying that, we see increasing risks for a US recession in late 2020 or early 2021. Overall, we expect global growth to remain modestly positive. Although markets have rebounded impressively so far this year, we remain alert to downside risks of further selloffs given uncertainty over US monetary policy and changes to global trade policies. Importantly, we believe this is an environment that will favour our active management approach.
1 The trade-weighted index for the AUD is an indicator of movements in the average value of the AUD against the currencies of our trading partners.