Market Commentary Quarterly Update
Global share markets rally
Stocks performed well through January and February, rising largely on the back of promising US-China trade talks and some positive 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.
Share markets were also well supported by encouraging earnings updates from the likes of Goldman Sachs, Exxon Mobil and Boeing, some better-than-expected US jobs and consumer confidence data, and fresh stimulus measures in China. However, gains were more muted in March as fears global growth is slowing intensified after both the Fed and the European Central Bank (ECB) turned significantly more dovish.
The Fed, who only in January adopted a "wait and see" approach to interest rates, went one step further in March and effectively ruled out any rate hikes this year, while the ECB pushed back their own guidance for rate increases and introduced additional stimulus.
Compounding investors" growth concerns was softer US and European manufacturing activity and a brief inversion of the US yield curve which has, in the past, signalled an impending recession. Stocks were also impacted by ongoing uncertainty surrounding Britain"s exit from the European Union and further political unrest in Spain and Italy.
At the country level, China posted very strong gains for the quarter, driven largely by Beijing"s promise of additional stimulus and encouraging trade talks with the US. Stocks were also significantly higher in the US, Europe, the UK and Japan.
Australian shares tracked their global counterparts higher over the period. Contributing to the local market"s gains were solid performances from the major miners, with the likes of BHP Billiton and Rio Tinto posting double-digit returns on the back of stronger commodity prices and fresh Chinese stimulus. Stocks also benefited from a decline in the unemployment rate to just 4.9%, the prospect of an interest rate cut after the Reserve Bank of Australia (RBA) adopted a more neutral stance on monetary policy, and a better-than-expected domestic earnings season; which is to say earnings were less bad than many had feared. Sentiment was further buoyed by promising US-China trade talks and a strong lead from major overseas markets.
Limiting the gains was yet another disappointing inflation reading, a softening in business conditions and disappointing fourth-quarter gross domestic product (GDP) figures.
RBA leaves interest rates on hold
The RBA left the official cash rate on hold at a record low 1.50% throughout the period; though the Bank did downgrade its 2019 growth forecast from 3.50% to 3.00% in February as it acknowledged risks to the economy had increased.
Moreover, in a subsequent speech, 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, saying the probability of a move in either direction appears to be more evenly balanced. Importantly, he reiterated the Bank"s relatively constructive outlook on the economy and noted that he doesn"t see a strong case for a change in the official cash rate in the near term.
At its latest (March) meeting, the Bank maintained its 2019 growth forecast, noting that the labour market remains strong and that underlying inflation is expected to pick up over the next couple of years, albeit gradually. The main uncertainty for the Bank continues to be the strength of household consumption in the context of weak growth in household income and falling housing prices in some cities; notably Sydney and Melbourne.
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"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.
Domestic economy expands, albeit modestly
The Australian economy continued its expansion in the final quarter of 2018, with GDP for the three months ended 31 December coming in at 0.2%; though the outcome was below the 0.3% growth that most economists had been expecting. Government spending contributed the most to the outcome, driven by continued work on a number of large-scale infrastructure projects at both the state and local levels. Meanwhile, household spending softened over the quarter and dwelling investment declined. On an annual basis, the economy grew 2.3%; down on the revised 2.7% growth recorded in the 12 months ended 30 September.
Australian dollar falls
The Australian dollar (AUD) was weaker in the first quarter; the local unit falling on the back of the RBA"s shift to a more neutral stance on interest rates, disappointing domestic growth and a further widening in the yield differential between Australian and US government debt. Limiting the decline were a better-than-expected domestic earnings season, encouraging jobs data and stronger commodity prices; notably oil and iron ore. The AUD also benefited from promising developments in US-China trade negotiations.
The AUD fell 2.5% against the British pound but gained 2.1% against the euro, 0.7% against the Japanese yen and 0.4% against the US dollar (USD). The broader Australian Trade-Weighted Index1 closed the quarter 0.3% lower.
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 Fed 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 2020. 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.