Market commentary: monthly update

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

Global share markets rise

Global share markets performed well in February, driven largely by optimism the US and China will soon end their year-long trade impasse and some encouraging rhetoric from US Federal Reserve (Fed) chairman, Jerome Powell. Hopes of a US-China trade deal rose after Donald Trump delayed an increase in US tariffs on Chinese goods amid "substantial progress" in negotiations between the two parties, while the Fed's Powell reaffirmed the bank's "patient" approach to interest rates.

Stocks also benefited from a surge in US jobs growth, a rebound in US consumer confidence and a series of encouraging US earnings results, with the likes of Exxon Mobil, Chevron and Google parent, Alphabet, all beating analysts' expectations.

Limiting the gains was news the UK posted its weakest annual growth in six years in 2018, and sluggish German growth; Europe's biggest economy narrowly avoiding falling into recession in the December quarter. Compounding this was data that showed manufacturing activity in the euro-zone contracted in February. Sentiment was also impacted by some softer Chinese economic data, ongoing Brexit uncertainty and further political unrest in Spain and Italy.

At the country level, Chinese stocks posted strong gains for the month as investors cheered the progress made in trade talks with the US. Share markets in Europe, the US, Japan and the UK were also higher over the period.

Australian shares made very strong gains in February. Strength across the 'Big Four' banks, which together make up a large chunk of the market, was a key driver of performance. Stocks in the Big Four rallied in the wake of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which was light on specific recommendations with respect to the banks' core business structures.

Stocks were also supported by some dovish comments from Reserve Bank of Australia (RBA) governor, Philip Lowe, stronger commodity prices and a better-than-expected domestic earnings season; which is to say earnings were less bad than many had feared.

Interest rates unchanged

The RBA left the official cash rate on hold at a record low 1.50% in February. In its post-meeting statement, the Bank said its central scenario is for the Australian economy to grow by around 3.00% this year and by a little less in 2020. This marked a downgrade to the Bank's December forecast, which was for growth to average around 3.50% in 2019.

Officials also noted that the labour market remains strong and that underlying inflation is expected to pick up over the next couple of years, albeit gradually. The Bank 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."

However, in a subsequent speech, RBA governor Philip Lowe conceded that softer growth had forced the Bank to move away from its tightening bias to a more neutral stance on monetary policy, noting that the probability of a move in either direction now appears to be more evenly balanced. Importantly though, he reiterated the Bank's relatively constructive outlook on the domestic economy and noted that he doesn't see a strong case for a change in the official cash rate in the near term. Lowe's comments came on the back of similarly dovish rhetoric from other central banks, including the US Federal Reserve and the European Central Bank.

At Russell Investments, we've abandoned our forecast of a rate hike this year due to the RBA's more cautious tone and risks surrounding the housing market. We now believe the Bank will keep interest rates on hold through 2019 and into early 2020.

Australian dollar falls

The Australian dollar (AUD) weakened in February; the local unit falling on the back of the RBA's shift to a more neutral stance on interest rates and a further widening in the yield differential between Australian and US government debt. The AUD was also impacted by a series of mixed domestic economic data and general US dollar (USD) strength. Limiting the currency's decline were some promising developments in US-China trade negotiations and stronger commodity prices, including iron ore, oil and copper.

The AUD fell 3.0% against the British pound, 1.7% against the USD and 0.6% against the euro. It rose 0.2% against the Japanese yen, while the broader Australian Trade-Weighted Index1 closed the month 1.5% lower.

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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