Market commentary: monthly update

Here is a summary of investment markets for the month of January 2019.

Global share markets rise

Global share markets performed well in January, driven in large part by promising US-China trade talks, news the US Federal Reserve (Fed) will adopt a ‘wait and see’ approach to future rate hikes, and a reasonable start to the latest round of US earnings updates, with the likes of Goldman Sachs, Citigroup and Boeing all posting solid results. In saying that, there were some notable misses, including Haliburton, Caterpillar and healthcare giant, Johnson & Johnson.

Stocks also benefited from some better-than-expected US jobs data and a temporary end to the (longest ever) US government shutdown after President Donald Trump signed legislation that gives negotiators until 15 February to strike a wider deal on immigration.

Limiting the advance was the European Central Bank’s admission that risks to growth in the region have shifted to the downside, further evidence Chinese growth is slowing and some gloomy rhetoric from the International Monetary Fund on the global growth outlook. Stocks were also impacted by news Italy fell into recession at the end of last year and some lacklustre German growth figures; Europe’s biggest economy expanding by just 1.5% in 2018. Sentiment was further impacted by ever-present geopolitical risks, including ongoing uncertainty surrounding Brexit and fresh political unrest in Venezuela.

At the country level, US and Chinese stocks posted some of the strongest gains for the month, though European, Japanese and UK stocks were also materially higher over the period.

Australian shares made good gains in January, driven by strong performances from major miners and energy producers, as well as some encouraging retail sales and jobs figures; the local unemployment rate dropping to just 5.0% in December. Stocks also benefited from encouraging US-China trade talks, the Fed’s shift to a ‘wait and see’ approach to monetary policy and a positive lead from major overseas markets.

Limiting the gains was yet another disappointing inflation reading, a softening in business conditions and late weakness across major financials ahead of the release of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

Interest rates unchanged

The Reserve Bank of Australia (RBA) didn’t meet in January, though there was little in the way of local economic data to suggest the Bank will deviate from current monetary policy any time soon. The official cash rate remained unchanged at an historically low 1.50% throughout 2018 with officials maintaining a consistent and, for the most part, upbeat assessment of the domestic economy’s growth prospects.

In its latest (December) post-meeting statement, the Bank said it expects growth to average around 3.5% in 2019, before slowing in 2020. Officials also noted that the labour market remains positive and that inflation, which remains below the RBA’s 2-3% target range, is expected to pick up over the next couple of years, albeit gradually.

Meanwhile, the outlook for household consumption remains a concern, with growth in household income low and debt levels high. The RBA concluded its latest meeting by saying that “taking account of the available information, the Board judged that holding the stance of monetary policy unchanged… would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

At Russell Investments, we still see a chance that the RBA will raise interest rates to 1.75% in the second half of 2019 as wage and price inflation rises further. However, in recent months, consensus expectations for the 2019 year-end cash rate have fallen from 1.75% to the current level of 1.50%. Moreover, market pricing points to a 50% chance of a rate cut by December 2019. In fact, there is much uncertainty surrounding the domestic interest rate outlook, with June 2020 cash rate forecasts by leading economists ranging from 0.75% to 2.25%.

Australian dollar rises

The Australian dollar (AUD) made good gains in January; the local unit rising on the back of optimism the US and China can reach a deal to end their trade impasse, stronger commodity prices and further encouraging jobs data. The AUD also benefited from general US dollar (USD) weakness after the greenback fell in the wake of some dovish comments from Fed chairman, Jerome Powell.

Limiting the currency’s advance was yet another soft inflation reading, further evidence growth in China is slowing and a widening in the yield differential between Australian and US government debt.

The AUD rose 3.0% against the USD, 2.3% against the euro and 1.5% against the Japanese yen. It fell 0.5% against the British pound, while the broader Australian Trade-Weighted Index1 closed the month 1.5% higher.

Looking ahead

Volatility returned in 2018 and will likely continue in 2019. As late-cycle risks rise, there are several issues which remain on investors’ minds, including tightening US monetary policy, global trade war escalation, budget conflict between Italy and the European Union, and uncertainty over Brexit. To add further complexity, it’s likely both economic and corporate earnings growth will slow in the US.

In a volatile equity market environment, we have a neutral view on global equities overall. We believe that Europe and Japan still represent better relative value compared to the US. For Europe, we believe consensus expectations have become too pessimistic. Our base case is for the negative risks associated with Italy’s budget, Brexit and global trade uncertainty to fade in 2019, and for European corporate earnings and economic growth to improve. We continue to like valuations for emerging markets equities, particularly given their attractiveness relative to developed markets. However, the threat of trade wars, slowing economic growth in China and a stronger USD temper our view.

For fixed income assets, we see the cycle as a headwind for bond markets, given the risk of rising inflation pressures and tighter monetary policy from major global central banks. We feel bonds remain expensive, especially given the US labour market is tight. Any selloff in bonds could be amplified if the Fed decides to raise interest rates at a faster pace than expected, and if global central banks shift further away from accommodative monetary policy stances. We believe high-yield credit remains expensive, which is typical late in the cycle when profit growth slows and concerns over defaults rise.

In terms of currencies, the Japanese yen remains our preferred currency. 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 USD has modest upside potential, driven by interest rate differentials between the US and the rest of the G10. The strength of US growth relative to the rest of the world will continue to have implications on USD movements. With the RBA unlikely to shift monetary policy, 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 2020. Overall, we expect global growth to remain modestly positive, with volatile equity markets to deliver mid-single-digit returns. Downside risks of further selloffs remain, 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.

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