Global share markets stronger
Global share markets rose in August. Contributing to the rise were further positive US earnings updates, with the likes of Apple, Nordstrom, Walmart and John Deere all beating analysts’ expectations. Interestingly, Apple became the first company ever to be valued at USD1 trillion after investors pushed up the company’s share price in the wake of their results.
Investors were also encouraged by better-than-expected earnings in Japan and Europe, some solid Japanese and German growth data and news toward the end of the month that the US had agreed a deal with Mexico to address key parts of the North American Free Trade Agreement, or NAFTA as it’s more commonly known.
Sentiment was further buoyed by US Federal Reserve (Fed) chair Jerome Powell’s continued optimism in the country’s growth outlook; a view supported by an upward revision to June quarter growth figures and news consumer confidence reached its highest level in 18 years in August. The US consumer accounts for around 70% of all US economic activity and so provides a strong indication as to the underlying strength of the country’s economy.
Limiting the advance were ongoing geopolitical concerns, including escalating trade frictions between the US and China, Washington’s decision to slap fresh sanctions on Tehran, and rising US-Turkey tensions after Turkish officials refused to release an American pastor accused of spying. We also saw Donald Trump’s former campaign manager, Paul Manafort, convicted of tax and bank fraud, and his personal lawyer, Michael Cohen, admit to acting illegally at the president’s direction.
Investor sentiment was further impacted by some disappointing Chinese economic data, generally weaker commodity prices and fears worsening economic crises in emerging markets such as Turkey and Argentina could spread.
At the country level, stocks in the US were stronger, with both the benchmark S&P 500 Index and the tech-heavy Nasdaq hitting fresh record highs in August. Stocks were also higher in Japan, but fell in the UK, Europe and China.
The Australian share market made good gains in August. The local market benefited from another round of positive domestic earnings updates, some encouraging jobs and retail trade figures and further corporate activity; this time within the telecommunications sector, where TPG Telecom and Vodafone agreed to merge in a deal valued at around AUD15 billion. Limiting the gains were mixed performances from the ‘Big Four’ banks amid the latest round of the Royal Commission, ongoing US-China trade tensions and heightened political uncertainty in Canberra after Malcolm Turnbull was ousted as Prime Minister.
Interest rates on hold
As was widely expected, the Reserve Bank of Australia (RBA) left the official cash rate on hold at a record low 1.50% in August. There were minimal changes to the Bank’s July post-meeting statement, with officials remaining cautiously optimistic without showing any urgency to deviate from current policy.
The RBA said it expects domestic growth to average a bit above 3.0% this year and next, employment growth to continue to improve and inflation, which is at the lower end of the RBA’s 2-3% target range, to be higher in 2019 and 2020 than it is currently.
Meanwhile, the outlook for household consumption remains a concern, with household income growing slowly and debt levels still high. 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.”
Recent softer wages and inflation data have dented our confidence in the pace of RBA rate hikes this year. Our expectation for a re-acceleration in inflation and wages growth proved to be too early, while the US rate hike cycle has proved to be less relevant than we’d anticipated. Whilst we maintain our view that the market is underestimating the Bank’s interest rate movements, we nonetheless believe it’s unlikely we’ll see any move from the RBA until the second half of next year.
Australian dollar falls
The Australian dollar (AUD) was weaker in August; the local unit falling amid declining commodity prices, the ongoing trade dispute between the US and China—our largest trading partner—and expectations the Fed will continue to raise interest rates at a time when domestic rates are set to remain on hold. Limiting the currency’s decline were a series of encouraging domestic earnings updates, some positive jobs and retail trade figures, and further merger and acquisition activity.
The AUD fell 2.5% against the Japanese yen, 2.3% against the US dollar (USD), 2.0% against the euro and 1.5% against the British pound. The broader Australian Trade-Weighted Index1 closed the month down 2.0%.
We expect volatility to continue through 2018 as investors contend with US policy agenda, potential further US rate hikes, higher bond yields and potential normalisation of monetary policy outside the US. Geopolitical uncertainty poses a further risk, with investors shifting their attention to the threat of trade wars after the US imposed tariffs on major trading partners. Acts of retaliation—particularly from China—could have material negative impacts on markets and will need to be watched closely.
Relative to the US, we still believe other developed markets represent better value. Despite the slowdown in early 2018, we remain upbeat on the health of European economies; though caution is warranted given rising near-term political risks.
Emerging markets assets have weakened recently from a stronger USD, but improving corporate earnings and resilient economic growth means they still offer attractive long-term value relative to their developed peers. In saying that, geopolitical risks remain along with the threat of tighter US monetary policy and a potential US-China trade war. Needless to say, with equity markets remaining expensive late-cycle, a cautious approach is warranted; particularly given the uncertainty around the pace of Fed rate hikes and global trade issues.
Our base case is for the Fed to raise interest rates a total of three to four times in 2018. We feel bonds remain expensive and may face headwinds in the form of potential rising inflation and higher US yields, especially given that the US labour market is tight. Any selloff in bonds could be amplified if the Fed decides to raise rates at a faster pace than expected, and if global central banks shift away from their accommodative monetary policy stances.
We hold an unfavourable view on high-yield debt, as valuations have become stretched given the compression in credit spreads to near-historical lows. Conversely, we favour local currency emerging markets debt, with fundamentals remaining strong.
In terms of currencies, the USD has staged a recovery, 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. We observe signs that the current USD rally is stretched, given overall market positioning and the recent improvement in economic data in other G4 regions. Our view is that the current rally is technical in nature rather than the beginnings of a renewed USD structural bull market.
We continue to hold a preference for the Japanese yen, given the solid economic data flow from Japan, including strong external demand and a tightening labour market. The yen is also attractive from a ‘safe haven’ perspective, as it is the currency most negatively correlated with global equity returns. Meanwhile, the future direction of the AUD is likely to continue to be influenced by movements in commodity prices together with any potential shift in the RBA’s stance on monetary policy.
Overall, we expect global growth to remain modestly positive through 2018, with downside risks of further 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, we believe financial markets will continue to provide further investment opportunities for 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.