Markets began the financial year positively, with stocks gaining amid expectations Britain’s decision to exit the European Union would have little impact on the global economy, further evidence China’s economy was stabilising and further encouraging US and European earnings results. Stocks also benefited from additional central bank stimulus; this time in the UK and Japan. In the UK, the Bank of England cut its benchmark interest rate in August to just 0.25% and expanded its stimulus measures while the Bank of Japan announced a variety of new stimulus measures at the same time as keeping its key policy rate unchanged. However, the gains were limited by weaker commodity prices and ongoing geopolitical uncertainty; the latter including a failed military coup in Turkey and rising tensions in the South China Sea.
Stocks came under more pressure toward the end of 2016 with sentiment impacted by increasing uncertainty surrounding the outcome of November’s US presidential election, US rate hike speculation and a sharp rise in bond yields. However, this negative sentiment reversed sharply in the wake of Donald Trump’s surprise election victory as investors bet his promises to cut taxes, ramp up infrastructure spending and ease regulation would help drive company profits higher. As a result, shares rallied through November and December with financials, energy and materials among the key beneficiaries. Stocks also benefited from another round of encouraging US and European earnings results, news OPEC’s members had reached an agreement to curb production and a series of improving US and Chinese economic data. Some profit taking, the US Federal Reserve (Fed)’s decision in December to raise interest rates and ongoing geopolitical concerns did weigh on stocks toward the end of 2016 but these weren’t enough to overshadow earlier gains.
Stocks began 2017 on the back foot amid doubts over Donald Trump’s ability to deliver on his pro-growth election promises, uncertainty stemming from his proposed travel ban on citizens of seven, mostly Muslim, nations and renewed fears of a ‘hard’ Brexit. However, sentiment turned more positive through February and March on the back of increasing optimism over the global growth outlook, some encouraging comments from Fed chair Janet Yellen and a series of better-than-expected earnings results globally. Stocks were also well supported by a softening in tensions between the US and China and expectations Trump will shift his focus to tax reform after he failed to get his healthcare reform bill through Congress. Meanwhile, the Fed’s much anticipated rate hike decision in March had a relatively neutral impact on stocks as investors had, for the most part, already priced in the move.
Share markets ended the year on a positive note, rising on the back of some strong earnings results from the likes of Alphabet (formerly Google), Morgan Stanley and Amazon, a series of positive US and European data points and a positive election outcome in France, where Emmanuel Macron secured a convincing win over Marine Le Pen in the country’s presidential election. However, the gains were limited by a sharp decline in oil prices, another Fed rate hike in June and concerns the easy monetary policies implemented by global central banks in response to the global financial crisis may be nearing an end. Sentiment was also impacted by heightened geopolitical risks, including ongoing US/North Korea tensions and the decision by several Middle Eastern countries to suspend diplomatic relations with Qatar over its alleged sponsorship of terrorist groups.
Global share markets made strong gains over the past 12 months, returning 18.9%1 in local currency terms. In unhedged Australian dollar (AUD) terms, stocks returned 14.7%2. Much of the gains were driven by increasing optimism regarding the global recovery and expectations the US economy – the world’s largest – is strong enough to withstand higher interest rates. Stocks also received a significant boost from Trump’s election win in November, though his failure so far to deliver on his campaign promises and his combative style of leadership have begun to weigh on markets. Ongoing geopolitical uncertainty, including Brexit, and expectations central banks will soon begin the process of unwinding their massive stimulus programs were also significant headwinds over the year.
At the regional level, stocks in Japan (28.6%3), Europe (20.1%4), China (16.3%5), the US (15.5%6) and the UK (12.4%7) all posted strong returns over the period8.
The Australian share market also made strong gains over the year with the S&P/ASX 300 Accumulation Index closing the period 13.8% higher. The local market benefited from the RBA’s decision to cut interest rates to a record low in August, the so-called ‘Trump bump’ in the wake of Donald Trump’s election win in November and general optimism regarding the domestic growth outlook. Stocks were also well supported by some encouraging Chinese economic data, a better-than-expected December-half earnings season and a positive lead from major overseas markets. However, sharp declines in the ‘Big Four’ banks in the final quarter of the period limited any further gains.
At the sector level, materials (24.6%), financials (20.1%) and utilities (19.7%) posted the biggest gains for the period. Telecommunication services (-21.2%) recorded the largest loss thanks to a sharp decline in sector heavyweight Telstra.
In terms of central bank activity, the Reserve Bank of Australia (RBA) cut interest rates just once over the year (in August). The decision came in the wake of a second consecutive soft inflation reading, with the consumer price index rising just 1.0% for the year ended 30 June 2016. At the time of the decision, the RBA noted that “recent data confirm that inflation remains quite low” and that “this is expected to remain the case for some time.” The move saw the official cash rate reduced from 1.75% to a historical low of just 1.50%, where it stayed throughout the remainder of the period as officials found themselves somewhat hamstrung by a combination of still-low inflation and concerns about an overheating property market. In saying that, officials remained optimistic about the domestic growth outlook, noting that the labour market is improving and that the broader transition to lower levels of mining investment following the mining investment boom continues to gather momentum.
Real estate investment trusts
Australian real estate investment trusts (REITs) struggled over the year, closing the period down 5.6%9. Arguably the biggest driver of underperformance was rising bond yields, particularly toward the end of the period as investors reacted negatively to speculation central banks may soon look to unwind their post-global financial crisis stimulus efforts. Limiting the decline were some positive earnings results, an improving domestic growth outlook and the sector’s traditionally defensive characteristics in the face of ongoing geopolitical uncertainty. In contrast, global REITs (2.2%10) posted reasonable gains over the year as improving global growth, Macron’s election win and a series of encouraging US and European earnings results offset late concerns about tighter monetary policy.
Bonds and cash
Global and domestic bonds both made modest gains over the year, returning 0.5%11 and 0.3%12, respectively. Yields on longer-term government debt – including our own – were higher (prices lower) for the period, driven by improving US and European economic data, Trump’s promises of tax cuts and greater fiscal spending, rising US interest rates and late concerns global central banks are getting closer to unwinding their stimulus programs. Meanwhile, credit markets were stronger as spreads continued to narrow in line with improving risk appetites.
Cash returned 1.8%13 over the past 12 months, underperforming all the major asset classes except global and Australian bonds.
The AUD ended the year higher; the local currency benefiting from a weaker US dollar (USD), stabilising Chinese growth and speculation the RBA has likely reached the bottom of its current tightening cycle. The currency also benefited from stronger base metal prices, including iron ore; though iron ore’s gains did disguise a sharp decline through the second half of the year. Limiting the gains were weaker oil prices, speculation toward the end of 2016 that Australia was at risk of losing its coveted AAA credit rating, and a late decline in bond yields. The AUD rose 13.0% against the Japanese yen, 6.6% against the British pound, 3.6% against the USD and 0.5% against the euro. The broader Australian Trade-Weighted Index14 closed the period up 4.8%.
Where to from here?
We expect volatility to continue in the second half of 2017 as investors contend with Donald Trump’s aggressive policy agenda, potential further Fed rate hikes, and potential normalisation of monetary policy outside the US.
Europe has benefited from an improved earnings outlook and receding political risks involving the spread of populism. Relative to the US, we still believe other developed markets represent better value, though we would like to see further signs of earnings growth and more confidence in the economic growth outlook. Emerging markets were thrown a curve ball by Trump’s election victory in November, as the possible rejection of international trade deals and the threat of higher global yields were both expected to have negative impacts. However, emerging economies have shown resilience, even in the face of recent Fed tightening. Whilst we believe emerging markets represent superior value relative to their developed peers on a longer time horizon, we nonetheless remain cautious about buying any dips.
Though bond markets have retraced some of their losses following the US election, we nonetheless maintain our neutral outlook for both government and investment-grade bonds. With interest rates still at historically low levels, we feel bonds are expensive and may face headwinds in the form of potential rising inflation and higher US yields; which could be amplified if the Fed decides to raise rates at a faster pace than expected over the remainder of this year and next, and if global central banks shift away from their accommodative monetary policy stances.
In terms of currencies, the prospect for US tax cuts, deregulation and increased fiscal spending, together with potentially higher US interest rates, could still lead to a rebound in the USD, however the timing and implementation of reforms is uncertain. Meanwhile, the future direction of the AUD is likely to continue to be influenced by movements in commodity prices, especially with the RBA expected to keep interest rates on hold in the foreseeable future.
Overall, we expect global growth to remain modestly positive through the second half of the year, with downside risks of further market selloffs as markets continue to adjust to potentially higher levels of interest rates and changes to monetary and fiscal policy, especially in the US. Importantly, though, we believe the second half will provide further opportunities for active management compared to the prior 12-18 months.
1 Global shares measured by the MSCI World ex Australia Net Accumulation Index in LC
2 Global shares measured by the MSCI World ex Australia Net Accumulation Index in AUD
3 Japanese shares measured by the TOPIX Index
4 European shares measured by the Dow Jones EuroStoxx 50 Index
5 Chinese shares measured by the Shanghai Shenzhen CSI 300 Index
6 US shares measured by the S&P 500 Index
7 UK shares measured by the FTSE 100 Index
8 Regional returns are in local currencies
9 Australian REITs measured by the S&P/ASX 300 Property Accumulation Index
10 Global REITs measured by the FTSE EPRA/NAREIT Developed Real Estate Index Net TRI (hedged to AUD)
11 Global bonds measured by the Barclays Global Aggregate Bond Index (hedged to AUD)
12 Australian bonds measured by the Bloomberg AusBond Composite 0+ Year Index
13 Cash measured by the Bloomberg AusBond Bank Bill Index
14 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.