Market Commentary September 2019
Here’s a summary of investment markets for the three months ending 30 September 2019
Global share markets rise
Global share markets performed well in the third quarter. Much of the gains can be attributed to expectations slowing global growth and ongoing trade disputes will force more central banks to cut interest rates. During the period, we saw further evidence global manufacturing activity is weakening, with the latest flash purchasing manager indices in the US, Europe and Japan continuing to underwhelm. At the same time, a lack of any meaningful progress in US-China trade negotiations sparked fears that a protracted trade war could eventually push the global economy into recession. In response, the US Federal Reserve (Fed) lowered its benchmark fed funds rate twice over the quarter and said it remains ready to act as appropriate to sustain the country’s current expansion. Elsewhere, both the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand cut their respective cash rates to record levels, while the European Central Bank reduced its deposit rate and introduced fresh stimulus measures; notably the resumption of quantitative easing. More broadly, share markets also benefited from some encouraging US earnings results, with the likes of Walmart, IBM, Microsoft and Coca-Cola all beating analysts’ expectations. In saying that, there were some notable misses, including Boeing and Caterpillar; both of which were impacted by Sino-US trade frictions. Limiting the gains were weaker commodity prices, the ongoing mess that is Brexit and some disappointing Chinese economic data; notably news the country’s economy expanded at its slowest annual pace in 27 years in the second quarter. Stocks were also impacted by fresh US political uncertainty after Democrats in Congress moved to impeach President Donald Trump, an attack on Saudi Arabia’s largest oil refinery and escalating civil unrest in Hong Kong.
At the country level, US stocks continued to hit record highs throughout the quarter, with the benchmark S&P 500 Index surpassing the 3,000 mark for the first time. Share markets were also higher in Japan and Europe but fell in China and the UK, albeit modestly.
Australian shares made good gains over the period, driven largely by the RBA’s decision to cut interest rates and looser monetary policy globally. Limiting the advance was weakness across the major miners, mixed performances from the ‘Big Four’ banks and a series of mixed domestic earnings updates. Sentiment was also impacted by news the local economy expanded just 1.4% in the year ended 30 June.
RBA cuts interest rates again
The RBA cut interest rates again in July; taking the official cash rate to a new low of just 1.00%. The move, which followed a similar cut in June, was made with a view to supporting employment growth and providing greater confidence that inflation will be consistent with the Bank’s medium-term target. In its post-meeting statement, the RBA noted that whilst employment growth remained strong, there had been little inroad into the spare capacity in the labour market recently, and that inflation pressures remained subdued across much of the economy. The RBA left interest rates on hold in August and September; though expectations for another rate cut in October gathered momentum after other central banks lowered their interest rates and the unemployment rate ticked slightly higher in August. The Bank has previously said that it believes the unemployment rate needs to fall to at least 4.5% in order to see a meaningful pick-up in inflation and wages growth. [Note: the RBA did in fact go on to cut interest rates again in October, lowering the cash rate to an all-time low of just 0.75%. The Bank said it will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.]
At Russell Investments, we were of the view that the RBA would likely cut interest rates twice from their 1.00% level. We saw the first of these rate cuts at the Bank’s early October meeting and we continue to believe another cut is coming; most likely in the first half of 2020. In saying that, global risks in the form of a further escalation in the US-China trade war or more accommodative central banks could bring this rate cut forward.
Domestic growth continues to disappoint
Australia’s economy slowed further in the second quarter of 2019, with gross domestic product for the three months ended 30 June coming in at 0.5%. Underpinning the softer result was further weakness in household spending, which contributed a mere 0.4% to the overall outcome as households continued to pull back on discretionary purchases. Consumers account for around 55% of all domestic economic growth. In contrast, net exports and government spending on aged care, health and disability services again helped prop up the result.
On an annual basis, the economy grew just 1.4%; down on the 1.8% growth recorded in the 12 months ended 31 March. Whilst the outcome was in line with most economists’ expectations, it was nonetheless the country’s worst annual growth rate since September 2009.
Australian dollar weaker
The Australian dollar (AUD) was weaker in the third quarter, falling on the back of the RBA’s decision to cut interest rates in July (and speculation of more to come), disappointing second-quarter growth data and weaker commodity prices. The currency was also impacted by some mixed corporate earnings updates, global recession fears and ongoing geopolitical risks. Limiting the AUD’s decline were multiple US interest rate cuts and some optimistic rhetoric on the local economy from RBA governor, Philip Lowe.
The AUD fell 3.8% against the US dollar (USD), 3.7% against the Japanese yen and 0.8% against the British pound. It was flat against the euro, while the broader Australian Trade-Weighted Index closed the quarter 1.5% lower.
Global markets have rallied in 2019, supported by central banks turning dovish and Chinese authorities announcing stimulus measures. However, yield curve inversion, trade war uncertainty and weakness in global macroeconomic data are pointing to elevated late-cycle risks. Whilst there’s a case for lower US interest rates and further Chinese stimulus to support another leg higher for risk assets, the recent escalation in the US-China trade war has us leaning incrementally more cautious. We still believe downside risks to equity markets outweigh the upside.
We retain a small underweight view on global equities overall, with the trade war slowing economic and earnings growth globally. Our largest underweight remains to the US where we believe valuations are expensive. In other major equity markets, we see Europe and Japan as fairly valued. Whilst emerging markets remain attractive from a value standpoint, tailwinds from further expected Chinese stimulus and dovish global central banks have been countered by global trade uncertainty and weaker measures of economic activity.
For fixed income assets, we anticipated the Fed’s interest rate cut in September and we expect another one in October. We believe that the Fed will want to act against further evidence of a global slowdown and the escalation of the US-China trade war. Our preferred positioning on duration is neutral, as there is cycle support for bonds that’s being driven by the dovish shift by global central banks and delayed inflation pressures. In credit markets, we believe high-yield debt is still expensive; though this 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, while the AUD is likely to continue to be impacted by monetary policy, commodity price movements and geopolitical risks involving China and other emerging markets.
We expect late-cycle risks to rise further with increasing risks for a US recession in late 2020 or early 2021. Overall, we expect global growth to remain modestly positive, however weakening global macroeconomic data and corporate earnings pose risks. 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.