Market commentary: monthly update
Global share markets tumble
Global share markets fell sharply in May. Much of the decline can be attributed to escalating US-China trade tensions and the potential impact a protracted trade war between the two countries will have on global growth. The war of words between Washington and Beijing went up several notches in May after US president Donald Trump raised the tariffs on USD200 billion of Chinese goods from 10% to 25%. Tensions escalated further after China retaliated with tariff increases of their own and Trump moved to blacklist the country’s top telco, Huawei.
Also impacting performance was an interest rates reality check from US Federal Reserve (Fed) chairman, Jerome Powell, and a series of disappointing manufacturing activity data globally. Fed chairman Powell took the wind out of investors’ sails when he said the market’s rate cut expectations might be too optimistic, while the latest flash purchasing manager indices in the US, Europe and Japan all underwhelmed. In fact, the US print revealed the country’s slowest expansion in overall business activity since May 2016.
Other factors to weigh on stocks were the European Commission’s move to trim its 2019 euro-zone growth forecast to just 1.2% and heightened Brexit uncertainty following British prime minister Theresa May’s decision to resign as leader of the Conservative Party. Sentiment was further impacted by Trump’s threat to slap tariffs on Mexico, which sparked fears that a trade war on multiple fronts could push the US economy into recession.
Limiting the decline was news the US jobless rate fell to its lowest level since 1969 in April, some encouraging US earnings results and an uptick in European corporate activity, including a potential merger between Fiat Chrysler and Renault. Stocks also benefited from news Japan’s economy expanded in the first quarter, with gross domestic product for the three months ended 31 March 2019 coming in at an annualised rate of 2.1%. The market had anticipated a 0.2% contraction.
At the country level, US stocks retreated from their recent highs in May. Share markets were also weaker in Japan, China, Europe and the UK. The New Zealand market bucked the global trend, with stocks there rising in the wake of the Reserve Bank of New Zealand’s decision to cut interest rates.
Australian shares were stronger for the month. The local market tracked its global counterparts lower in the first half of the period before staging a strong turnaround on the back of the Coalition’s surprise election win and some dovish comments from Reserve Bank of Australia (RBA) governor, Philip Lowe. Stocks also benefited from some encouraging retail sales and consumer confidence data, further corporate activity and good gains across the major miners. Limiting the advance were some mixed domestic earnings updates, softer housing-related data and a modest uptick in the local unemployment rate; though the latter was driven by a big jump in the participation rate.
Interest rates unchanged
The RBA left the official cash rate on hold at a record low 1.50% following its early May meeting. In its post-meeting statement, the Bank said its central scenario is for the Australian economy to grow by around 2.75% this year and next, supported by increased investment in infrastructure and a pick up in activity within the resources sector. The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices.
The RBA also noted that the labour market remains strong and that inflation should pick up gradually, with underlying inflation expected to be 1.75% this year, 2.00% in 2020 and a little higher after that.
In concluding its latest meeting, the Bank judged that it was appropriate to hold the stance of policy unchanged. In doing so, it said it recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target.
Note: The RBA went on to cut the official cash rate from 1.50% to a new low of just 1.25% at its early June meeting. Moving forward, we believe market pricing and expectations of another rate cut in July or August is likely too soon. We expect the RBA will prefer to wait and see how labour market data in particular evolves. We’re also looking to see how much of a rebound is seen in business confidence, which may provide some insight into hiring intentions.
Australian dollar falls
The Australian dollar (AUD) was weaker in May, falling to levels not seen since early 2016. The local unit was impacted by the escalation in US-China trade tensions, rising domestic rate cut expectations and an increase in the unemployment rate. Also weighing on the currency were some mixed earnings updates and weaker commodity prices; though iron ore was a notable exception. Limiting the decline were better-than-expected retail sales, consumer confidence and trade data, further corporate activity and a strong, albeit short-lived, bounce in the wake of the Coalition’s surprise election win.
The AUD fell 4.0% against the Japanese yen, 1.7% against the US dollar (USD) and 1.3% against the euro. It rose 0.8% against the British pound, while the broader Australian Trade-Weighted Index1 closed the month 0.8% lower.
Global markets began 2019 positively as central banks turned dovish and Chinese authorities announced stronger-than-expected stimulus measures. However, downside risks have recently emerged from the escalating trade war between the US and China. Late-cycle risks remain elevated and markets remain conflicted between incoming data that’s pointing toward slower global growth and forward-looking indicators 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. In 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. Meanwhile, emerging markets have benefited from Chinese stimulus and the tailwinds from a pause in US rate hikes. However, the outlook for emerging markets is uncertain due to the recent escalation in the US-China trade war.
For fixed income assets, the delay in Fed tightening has reduced the cycle headwinds for bond markets. We still think the next Fed move is likely to be a cut, though this may be delayed until 2020. Many bond markets remain very expensive given yields are well below fair value, especially in Germany and Japan. In credit markets, we believe high-yield bonds are still 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 hold a neutral view on the USD, as worsening economic data is a headwind. The strength of US growth relative to the rest of the world will continue to have implications on USD movements. Meanwhile, we think the AUD will continue to be impacted by monetary policy, 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.